Management Notes

Management Notes

Reference Notes for Management
During inflation

During inflation

by

During inflation

    1. Lenders lose, borrowers gain
    2. Borrowers lose, lenders gain
    3. Borrowers and lenders both lose
    4. All sections of the society gain

Correct Answer: Lenders lose, borrowers gain

 Answer Explanation

The correct answer is (a) Lenders lose, borrowers gain. Inflation, the steady increase in the general level of prices over time, has distinct effects on lenders (those who lend money) and borrowers (those who borrow money).

As a result of inflation, lenders lose, and borrowers gain: During inflation, money loses its real value. Fixed interest lending causes lenders to receive less purchasing power when they are repaid for the loan when it is repaid. Essentially, they are repaid with money that has eroded in value due to rising prices. This results in a reduction in the lender’s effective interest rate. Therefore, lenders receive lower real returns on their loans, resulting in a loss in purchasing power.

As a result, borrowers gain when inflation occurs. When borrowers repay their loans with money that has decreased in value, they are effectively repaying a smaller percentage of their actual purchasing power compared to what they originally borrowed. In essence, they are repaying their debts with money that is worth less in real terms. Therefore, borrowers experience a decrease in real debt burden, which is a positive development.

Why the other options are not correct

b. Borrowers Lose, Lenders Gain:

This option contradicts the fundamental impact of inflation on borrowers. Borrowers benefit from inflation because they have a decrease in the value of their debt as time passes. As prices rise, the money they use to repay their loans has less purchasing power, resulting in a decrease in the effective debt burden.

While lenders face eroded purchasing power, they do not gain from inflation because their purchasing power is eroded.

c. Borrowers and lenders both lose:

While it is true that both borrowers and lenders are affected by inflation, characterizing both parties as losing is not correct. Since borrowers repay loans with diminished purchasing power, they gain an advantage during inflation, as explained above. The lenders, on the other hand, experience a reduction in real returns, which indicates a loss in purchasing power.

d. All Sections of the Society Gain

Inflation has varying effects on different segments of society, and the notion that all sections of society gain during inflation oversimplifies the complex economic implications. Those with fixed incomes, such as retirees living on pensions, may experience a decrease in their purchasing power, whereas those with borrowed money will benefit from a reduced financial burden.

Conclusion

The impact of inflation on lenders and borrowers is distinct and asymmetric. Lenders lose real value due to the diminished purchasing power of the money they receive when repaying loans. On the other hand, borrowers gain when inflation occurs since they are able to repay loans with money that is worth less than when they borrowed them.

It is important to consider inflation when making financial decisions based on this understanding of how inflation affects lending and borrowing. The implications of inflation play a crucial role in determining the real returns and the effective burden of financial transactions, whether one is lending or borrowing.

Inflation can be controlled by applying:

Bibisha Shiwakoti
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