Effects of Inflation on Suppliers and Demanders

Effects of Inflation on Suppliers and Demanders
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  • 0:07 Suppliers and Demanders
  • 1:12 Anticipated vs.…
  • 3:05 Effects on Suppliers…
  • 6:48 Lesson Summary
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Lesson Transcript
Instructor: Jon Nash

Jon has taught Economics and Finance and has an MBA in Finance

In this lesson, you'll discover who benefits and who suffers from a sustained increase in prices within an economy. We'll cover the effects of expected and unexpected inflation on savers/creditors and borrowers/debtors.

Effects of Inflation on Suppliers and Demanders

I want you to imagine for a minute several people in your neighborhood, each of whom is invited to a neighborhood block party. This neighborhood block party is going to happen in a few hours. So here's a description of your neighbors:

  • Alyson is a retired woman living on Social Security payments.
  • Lydia is a neighbor who works on an assembly line in a car factory.
  • Frank is a farmer who just bought a tractor for his farm, which is next to his house.
  • Davis is a neighbor who just closed a 30-year, fixed-rate mortgage on his new home.

Let's say that last year the inflation rate was 3%. People are expecting this year to be 3% also. However, an hour ago, each of these neighbors discovers, while watching the national news on television, that inflation is actually 5% - it's not 3% like everyone expected, it's 5%. As you watch the same news report on television, you begin to ask yourself the question: which one of your neighbors is going to be happy at the party?

Let's look at this from an economic perspective. What we want to know is: What are the effects of inflation on suppliers and demanders? Another way to say this is: Who gets hurt and who gets helped by unanticipated, or unexpected, inflation? Anticipated inflation is a sustained rise in the price level that is expected ahead of time. Inflation that is anticipated, or expected, isn't as bad as unanticipated inflation, which is a higher-than-expected sustained increase in the price level. When inflation is expected, it gets included in the price of goods and services today, as well as the interest rates on loans and various investments. Anticipated inflation benefits anyone whose income is tied to inflation. An example of this would be workers with ongoing cost-of-living adjustments that are tied to inflation.

The effects of inflation on lenders and borrowers depends on whether it is anticipated or not.
Saver Borrower Inflation

Let's spend the majority of our time in this lesson talking about unanticipated inflation. Unanticipated inflation hurts savers and creditors because the money they lend out gets paid back in cheaper dollars over time. On the other hand, unanticipated inflation helps borrowers and debtors because they borrow money at a fixed rate and pay it back in cheaper dollars over time. Here's another way to say this: unanticipated inflation redistributes wealth from savers to borrowers. When you're trying to determine who is hurt or helped by surprise inflation, you have to first determine if they are considered a saver or creditor (meaning that they loan out money) or are they are a borrower or debtor (meaning that they are borrowing money).

Let's look at inflation's effects from all the guests invited to the neighborhood block party. Remember, Alyson is a retired woman living entirely on Social Security income, so that's how she gets her money every month. The check comes in the mail from Social Security, she puts it in her bank account and that's what she lives on. Is she hurt or helped when she finds out that inflation is actually 5% when we were expecting 3%? Social Security is like a savings account in that it pays fixed income payments over time to individuals. That means she would be considered a saver, and we know that savers are hurt by unanticipated inflation. When she receives the same fixed payment over time, it will actually be worth less and less in terms of the goods and services it will afford her. Unfortunately, Alyson is going to be quite sad at the party!

Frank (is a farmer I said) borrowed money to buy a new tractor. Therefore, is Frank going to be hurt or helped? We know that borrowers are helped by unanticipated inflation, so this farmer benefits because his monthly payments on the tractor he borrowed the money to buy will actually be worth less and less. He'll be paying back his loan in cheaper dollars. So that means that at the party, Frank's going to be very happy.

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