If there is rapid inflation causing fast growth in prices, or inflation moves around a lot, then:
- Lower purchasing power. When there is high inflation in the country, workers’ wages and managers’ salaries will not buy as many goods as before. Employees will be asking for higher wages and salaries because their relative purchasing power decreases. This will be adding extra pressure on businesses to maintain previous profit margins. When people’s real incomes fall because prices grow faster than income, citizens will feel poorer, therefore more dissatisfied with their lives.
- Complicated unpredictability. During the periods of high inflation, it is hard for businesses to set the right prices, and for people to plan their spending. Hence, business planning and decision-making will be more complicated. Unpredictability about future prices, costs and profits may easily discourage entrepreneurs from starting businesses. Also, value investors will be discouraged from investing in businesses as they will not be able to accurately predict their future returns from investments – dividends and capital gains. Hence, it will be riskier for them to invest their money. Business owners may not want to expand their firms, and this will lead to less jobs being created in the economy in the future.
- Higher Variable Costs (VC) leading to lower Gross Profit. Prices of inventories of raw materials that are used to produce goods and provide service will increase. Production workers will be asking for higher wages because now they will be able to buy less products with the same amount of money, as their money is losing value. This will affect especially the lowest paid factory workers. So, it will lead to higher Variable Costs (VC) that increase the cost of production, or Cost of Goods Sold (COGS), therefore decrease Gross Profit.
- Higher Fixed Costs (FC) leading to lower Net Profit. Firms will also need to change prices frequently which will add extra workload to employees in the marketing department. Marketing managers will be busy with frequently updating tag prices, catalogue prices and menu prices. This will increase Fixed Costs (FC), or expenses, therefore decrease Net Profit.
- Lower competitiveness of the country. World economies will see changes in relative prices between different countries. In countries with high inflation, prices of products produced in those countries will be higher. In countries with low inflation, prices of products produced in those countries will be lower. So, people in countries with high inflation will buy foreign goods from countries where inflation, yet prices, is lower. This will negatively impact domestic producers who are now less competitive against imported products.
In 2020, ValueWalk published a very interesting article called TOP10 Countries With The Highest Inflation Worldwide.
Inflation matters because it affects not only individual people but also all businesses.
