Answer:
Consider the effects of inflation in an economy composed of only two people: Jacques, a bean farmer, and Kyoko, a rice farmer. Jacques and Kyoko both always consume equal amounts of rice and beans. In 2016 the price of beans was $1, and the price of rice was $4. Suppose that in 2017 the price of beans was $2 and the price of rice was $8.
- Since the inflation rate was 100% and affected both products in the same manner, Jacques and Kyoko will be unaffected by inflation.
Now suppose that in 2017 the price of beans was $2 and the price of rice was $4.80. Indicate whether Jacques and Kyoko were better off, worse off, or unaffected by the changes in prices.
- Since the inflation rate of beans was 100% and the inflation rate of rice was 20%, Jacquues will benefit from it and he will be better off. Kyoko will be worse off.
Now suppose that in 2017, the price of beans was $2 and the price of rice was $1.60. Indicate whether Jacques and Kyoko were better off, worse off, or unaffected by the changes in prices.
- Since the price of beans increased by 100%, while the price of rice decreased by 60%, Jacques will be extremely benefited while Kyoko will be hit extremely hard and will be much worse.
What matters more to Jacques and Kyoko?
- Relative prices matter than general inflation level.