First, a high level of inflation introduces business uncertainty and hence reduces investors’ incentive to invest. Specifically, hyperinflation disrupts the derivation of cost of production, making it difficult to set price which discourages trading activities and heightens the cost of investment. This contributes to lower investment rate in the country, which raises a cause of concern for government to maintain price stability.
In contrast, price stability via a mild level of inflation is desirable as it stimulates investment. Mild inflation raises production and national income when inflation rate is low as it induces growth of profitability. As production cost lags behind product prices, producers can pass on the rising cost condition to the consumers, enabling to gain greater revenue and profitability.
In addition, price stability, via modest price appreciation, will raise revenue under price-inelastic demand condition and when increase in total revenue is higher than the increase in cost of production, profitability will rise and entrepreneurs are more willing to invest because of their expectations of higher profit margins.
This article is contributed by Mr. Simon Ng, founder and principal JC Economics Tutor of Economicsfocus, who has 20 years of teaching experience. Currently, Mr. Simon Ng provides specialized Economics Tuition and GP Tuition. To read more articles on Economics issues and skills development, please refer to the JC Economics Essays blog.