Effects of changes in prices

Effects of changes in prices

Changes in prices affect different sections of the community in different ways. They affect production and distribution too.

1.  Effects on production

If prices are rising, it will stimulate production. Under a capitalistic system, production is carried on mainly for profits. During a period of rising prices (inflation), there will be abnormal profits. This increases production. So manufacturers and businessmen gain during inflation. Producers and businessmen gain during inflation. Producers gain by inflation because during that period prices rise faster than costs. So they make huge profits. But if inflation becomes hyper-inflation, it may end in a crash. On account of the rapid fall in the value of money, profits which are in the form of money may become worthless. And there will be a 'flight from currency'. Inflation may become an important cause of 'violent revolutions and economic chaos'.

In a period of falling prices, businessmen incur huge losses because prices fall faster than costs. And there will be little scope for investment. This results in unemployment on large scale. There will be business depression. During depression, money may be cheaply available, prices of materials will be low, men will be available for work but there will be no investment, no employment, no incomes and no demand for goods. Such a situation has been described as 'poverty in the midst of plenty.' The Great Depression of 1930s is a case in point.

2.  Effects on Distribution

        Business class : During inflation, manufacturers and businessmen make huge profits. Of course, during deflation, they make losses.

Fixed income groups : People in fixed income groups are hit hard in times of inflation. The incomes of wage earners and salaried people such as teachers, clerks and judges do not increase as fast as prices. Even retired people getting pension are also affected during inflation.

Wage earners and salaried - people gain during a period of falling prices. But it is not a real gain because many people will lose their jobs during deflation. Unemployment is a worse evil than rising prices.

1.        Investors : people who have invested their money in 'gilt edged' securities (government securities) will get only fixed income. So their position is like those in the fixed income group. But those who have shares in companies will make profits during a period of rising prices and lose during a period of falling prices. In Germany, thousands of middle class families were ruined during the inflation because all their lifetime savings were reduced to nothing by the tremendous rise in prices. If the value of money falls continuously, it becomes unsuitable as a store of value. People will not save at all.

2.        Rentiers : Rentiers gain during deflation and lose during inflation. But the gain during deflation is only a temporary feature.

It can be seen from the above discussion that violent changes in prices are a bad thing. Both inflation and deflation are great evils.

'Inflation is unjust and deflation is inexpedient' (disadvantageous). Some economists believe that of the two, deflation is worse because it results in unemployment. That is why it is now generally agreed that a steadily rising price level is a good thing for economic progress and social justice. We may agree with Robertson when he says that 'money which is a source of so many blessings to mankind, becomes also, unless we can control it, a source of peril and confusion'.