Unit 1
Unit 2
Inflation
Businesses
Inflation will affect the way that businesses act in the Australian economy as well. We have just seen that consumers are likely to be affected in a negative way when inflation is high. It is also true that businesses will suffer when inflation is high. One important difference here is that the impact on businesses is more likely to be long term; while consumers will find that their spending patterns are affected during times of high inflation, businesses might find that their productive capacity is affected for years to come.
Imagine that you own a business, and you are considering expanding. In recent times business has been good, and so you have thought about opening a new outlet in another suburb. The path that you take will be affected by the rate of inflation.
First, imagine that the rate of inflation is relatively low. When inflation is low, it is very difficult to make money through buying an asset and waiting for it to increase in value. If a business owner wants to increase his or her wealth during this period, the best option is to find some way of expanding capacity. In other words, during a period of low inflation it is very likely that the business will open the new outlet. It is also true that during this period the business is far more likely to be able to predict future costs, and that makes it easier to complete a budget. Once again, this suggests that it is more likely that the new outlet will be opened at this time.
Now consider what might happen if the rate of inflation was very high. At this time, the owners will know that future sales are far more difficult to predict. Rising prices will mean that they won’t be able to secure stock at a set rate, and therefore they won’t be able to confirm selling prices for anything other than a short period of time. Finally, as prices are increasing the owners will also be aware that they could use their money to increase their wealth in a much easier way. A high rate of inflation means that interest rates will also be high (in order to fight the inflation), and so the owner might choose to use a term deposit. This is a much safer investment, and as the return is better it makes sense to use it at this time. On the other hand, if asset values are increasing (due to the high inflation) then it might be easier to just buy an asset and wait for it to increase in value. This will require less work, and might still generate an increase in wealth. Many people in Australia did this in the 1980s when land prices were increasing; they bought a block of land, and then waited.
The first option is known as productive investment. When inflation is low, businesses are more likely to engage in productive investment. This means that our productive capacity will increase. In the example above, low inflation resulted in the business opening the new outlet. This means that more people will be employed, and the overall level of output generated by the business will be higher. As more goods or services are now being provided, we can see that productive capacity has increased. More products are available to people in Australia, and so more needs and wants can be satisfied. Overall living standards will be higher.
On the other hand, the second option is known as speculative investment. A speculator is a person who tries to make a profit through circumstances rather than business acumen. In this case, rather than opening the new outlet, a high inflation environment will encourage the owners to use their money to increase their wealth in other ways. The end result is that productive capacity in the economy is not increased, and jobs are not created. Worst of all, we have not created a situation in which more finished products are offered to the public, and so we can’t satisfy more needs and wants. Given the prevailing inflation, living standards will be lower.
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