Rich's Production Plans in Response to Inflation Forecasts

How Rich Will Adjust His Production Plans Due to Inflation Forecasts

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Question

Rich owns a shoe factory. He believes that a recent monetary policy announcement will cause 5% inflation over the next year, equally effecting the price of shoes, the cost of inputs, and wages. How will Rich change his production plans considering this forecast?

Answers

A. He will try to hide this information from his laborers.

B. Cannot determine, this depends on how much prices actually inflate over the next year.

C. He will increase shoe production because the expansionary monetary policy should boost consumer confidence and hence shoe demand.

D. No changes.

E. He will increase shoe production to take advantage of higher prices.

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Explanations

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A. B. C. D. E.

Anticipated inflation is always a wash for both consumers and producers, therefore Rich would not change his production plans. Remember that possible secondary effects, like an increase in consumer confidence, cannot be assumed. How high actual inflation is during the year is irrelevant since planning is based on forecasted inflation. This is an important concept for understanding how policy effects decision making. Note that if the entire economy thought exactly as Rich did, the expansionary monetary policy will have no real impact on the economy.

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