Lec1720220324 - 25-26

Costs of Inflation—1 Shoe-leather Costs m Suppose workers who face inflation tax - (the real wealth drops as the price level rises). - To avoid the loss in real wealth (inflation tax), people minimize their money holdings during periods of rapid inflation. - They may attempt to spend their earnings on physical goods as quickly as possible, or convert their money to foreign currencies of a nation with a lower and more stable rate of inflation (i.e. Zimbabwe people use US dollars). m The trips and errands to convert money to physical goods or foreign currencies incurs time and efforts. Figuratively, these costs are expressed by the wear and tear on people's shoes. m The inconvenience associated with minimizing money holdings are known as shoe-leather costs. Principles of Macroeconomics 672
Costs of Inflation—2 Menu Costs m Suppose firms that deal with the situation that the prices of intermediate goods increase rapidly - Rapid inflation forces firms to change their prices more frequently to ensure stable flows of revenues - If they don't change their prices frequently enough as the prices of intermediate goods rise, they will lose their profits m The costs associated with changing price tags/price lists/website content/catalogs/menus and with hiring people for these jobs are known as the menu costs of inflation. Principles of Macroeconomics 673
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