Economic consequences of inflation.

Inflation is the sustained increase in the general level of prices. This means that the average prices of goods and services, keeps on rising.

There are two types of inflation, demand-pull inflation, which is caused due to the increase of aggregate demand and cost-push inflation, caused due to the increase in costs of factors of production. Inflation is measured by the Consumer Price Index (CPI). It is a weighted price index and calculates the increase in price of commodities on a monthly basis by monitoring spendings of private households.

Inflation can have positive as well as negative effects on the economy. If the prices of commodities increase in UK, this will affect the competitiveness of UK products. They will become more expensive causing a fall in demand, which will lead to a recession in the UK economy.
Inflation can increase the production costs of UK firms. Labour will become very expensive to employ because of their higher wage rates demands. If employed at higher wages, this will add to the production costs which will in turn cause cost-pull inflation, causing further higher wage demands by employees. Thus inflation can lead to a wage-price spiral or even unemployment if employees refuse to work for lower wages or employers refuse to employ them causing the real value of income to fall. Land and capital will also be unemployed as due to lesser employment of labour as production process will slow down and eventually firms will experience a decrease in their profits.
Inflation will also cause a reduction in the real value of savings as prices will increase causing the current savings will loose its purchasing power.
Moreover, consumers on fixed incomes like pensioners will suffer the most. This is because as inflation increases and their pension remain the same; the real value of their income will decrease, as it will be able to purchase fewer goods and services.
Furthermore, firms will face uncertainty in terms of investments and price policies. This will also cause budgeting problems. They will not be able to keep a stable price and will not be sure about investments in products despite their prices rising, as they will experience very high production costs too.
Besides this, there will be increase in administration costs like menu costs for retailing firms and shoe leather costs as firms search for investment that will give maximum profits.

But however, a small and steady increase in the prices of commodities will also be beneficial for the economy. Inflation happens as aggregate demand increases. This will be a signal and an incentive for firms to produce more. This will then lead to more employment opportunities and then to more supply. Thus a steady inflation helps to move towards booms.

On the contrary, all these benefits and costs of inflation depend on the rate of inflation and whether it is stable or accelerating. If it is high and accelerating, the costs will be more severe with very little benefits, and a low and stable rate of inflation keeps the economy moving. If inflation happened, and it was expected, this will not result in severe costs as firms can be prepared to cope with it and decide their price policy and government may also control the situation by giving subsidies to help with production. In addition, it also depends on the value of the currency in terms of other currencies. If inflation in UK is higher than the rest of the world but UK currency is also stronger then the rest of the world, the demand for UK products will decrease, as they will become expensive. On the other hand if inflation is low and UK currency is also weak, then UK goods wil be cheap and their demand will increase. However the demand of UK products also depend on their elasticity. If they are inelastic and their prices rise and cleverly planned advertisement is done, they will still be demanded. The demands of higher wage rates will depend on the maximum wage set by the government. And last but not the least the real value of money and its purchasing power will only decrease if the interest rates or incomes rise more slowly then the rate of inflation.