Inflation and Business

Inflation and Business: Effect of inflation on consumers

Inflation reduces consumer purchasing power since it takes more money to buy the product now than it did in the past. If people’s incomes fail to keep up with the rise in average price levels, the inflation rate, and consumer spending will drop, resulting in lower demand and sales revenues for businesses.

An extreme case of inflation is hyperinflation.

Hyperinflation often takes place during financial crises or war times when the central bank prints an excessive amount of money. With the supply of money exceeding the demand, the value of money drops, causing a surge in the prices of goods and services. As the prices of necessities such as flour, meat, and fuel skyrocket, people can no longer pay for their standard living needs. The economy will suffer from poverty, unemployment, and many other social issues.

Effect of inflation on business

With inflation, employees will need a higher income to pay for daily expenses. They may ask for a pay rise, which results in higher costs for businesses. These costs will be transferred to the consumers in terms of higher prices, which adds to inflation.

People will spend more as their income increases. Thus, to stimulate spending, the government can increase the minimum wage so that businesses have to pay their employees more. However, more wages also mean higher prices of goods and services, which leads to inflation. This is known as wage push inflation. If the increase in income does not match inflation, people's real wages will drop and they will have less money to spend on products and services. This means lower sales revenues for the company.

Inflation also has an impact on international trade. Supposing the inflation rate is higher in the UK, goods produced by UK manufacturers will become more expensive compared to other countries. This will reduce their competitiveness and demand in the global market.

In the following sections, you will see the positive and negative outcomes of inflation on business:

Positive effects of inflation on business

A low level of inflation can have many positive impacts on the performance of businesses.

First, with inflation, companies can sell their products at a higher price and generate more revenues. This means more profits to be distributed among shareholders.

Second, inflation encourages people to take out more loans, as they can repay the money at a lesser rate than they borrow. The increase in borrowing and lending activities will lead to an overall increase in spending and economic growth.

Both individuals and businesses may take advantage of inflation to borrow money and invest in new machinery for higher productivity. Higher productivity will result in more output, which requires companies to hire more workers. Thus, inflation can contribute to an increase in jobs in an economy.

Negative effects of inflation on businesses

However, inflation is not always beneficial to an economy. A high rate of inflation can have many implications on business performance.

First of all, a higher inflation rate means that people’s real income (income after taking into account inflation) will drop, causing them to spend less money on goods and services, which results in lower demand and lower sales for businesses.

Without capital reserve in times of falling demands, businesses will not be able to pay for daily expenses and eventually go bankrupt. Lower business earnings also mean fewer tax revenues for the government, causing a delay in public projects and reduced social welfare.

In addition, when the price levels increase drastically, people may be unsure about the future and start making speculative investments - the investment in assets such as real estate, stocks, gold, etc., to make quick profits under the assumption that the price will continue to rise.

The problem with speculative investment is that the market can burst anytime, leaving investors with much less money than what they had originally invested. Businesses should assess the market carefully during inflation to avoid devastating outcomes of excessive speculation.

Inflation will also put lenders in a worse financial position as they receive less money than they have lent out. For companies that issue bonds, inflation is the worst enemy. With higher inflation, investors will demand higher yields from companies to compensate for the loss in purchasing power caused by inflation.

Finally, inflation can cause the price of exports items to rise, which lowers their demand in the global market and less revenue for the home country.

Effects of low inflation on business

Low inflation is a favourable situation for businesses and can result in:

• Higher exports value since the prices are lower and more competitive

• More investment by firms as they can take advantage of low inflation to borrow more money

• More real income and purchasing power for the employees

• Economic growth as the level of spending and output increases.

Over the course of time, the price of goods and services will increase. This is known as inflation. Inflation is a natural phenomenon in any economy and can have both negative and positive impacts on businesses and consumers. Usually, a low rate of inflation is positive, as it increases real wages, leading to more consumption and demand for goods. As demand increases, businesses can generate more revenues, increase their output and hire more people.

Source:

1. Lebanon’s Inflation Rate reached 144.12% by September 2021, Blomiminvest Bank, 2021.

2. Philip Aldrick, 1990s Lesson: Recession Is The Price of Curbing U.K. Inflation, Bloomberg, 2022.