What are the Effects on Production of Inflation ?

According to Keynes, moderate or creeping inflation has favourable effect on production particularly when there are unemployed resources in the country. Rising prices increase the profit expectations of the entrepreneurs because the prices increase more rapidly than the cost of production.

They are induced to step up investment, and, as a result, output and employment increase. Hyper or galloping inflation, on the other hand, creates the uncertainty which is inimical to production.

Thus, while mild inflation is favourable to production and employment particularly before full employment, hyper inflation is generally harmful for the economy. The adverse effects of inflation or production are stated below:

1. Disrupts Price System:

Inflation disrupts the smooth working of the price mechanism, creates rigidities and results in wrong allocation of resources.

2. Reduces Saving:

Inflation adversely affects saving and capital accumulation. When prices increase, the purchasing power of money falls which means more money is required to buy the same quantity of goods. This reduces saving.

3. Discourages Foreign Capital:

Inflation not only reduces domestic saving, it also discourages the inflow of foreign capital into the country. If the value of money falls considerably, it may even drive out the foreign capital invested in the country.

4. Encourages Hoarding:

When prices increase, hoarding of larger stocks of goods become profitable. As a consequence of hoarding, available supply of goods in relation to increasing monetary demand decreases. This results in black marketing and causes further price-spiral.

5. Encourages Speculation Activities:

Inflation promotes speculative activities on account of uncertainty created by a continually rising prices. Instead of earning profits through genuine productive activity, the businessmen find it easier to make quick profits through speculative activities.

6. Reduces Volume of production:

Inflation reduces the volume of production because (a) capital accumulation has slowed down and (b) business uncertainty discourages entrepreneurs from taking business risks in production.

7. Affects Pattern of Production:

Inflation adversely affects the pattern of production by diverting the resources from the production of essential goods to that of non-essential goods or luxuries because the rich, whose incomes increase more rapidly, demand luxury goods.

8. Quality Falls:

Inflation creates a sellers market in which sellers have command on prices because of excessive demand. In such a market, any thing can be sold. Since the producer’s interest is only higher profits, they will not care for the quality.