Concept Introduction:
Deflation: When the average price level decreases continuously for a given interval in an economy then it is referred as deflation. It leads to a recession in an economy. Deflation is not healthy for an economy.
Inflation: When the price of any good increases continuously for an interval of time it is called inflation. It leads to a decrease in the
Hyper-inflation: When the inflation rate is very high and is usually for a longer duration then it is termed as hyper-inflation. It has a very harsh impact on an economy as it leads to depression.
Inflation Tax: It is a tax which is bared by the asset or the income holders due to an increase in the rate of inflation. It is a kind of
The formula to calculate inflation tax is,
Explanation of Solution
a. Real inflation tax paid by Ms. Maria
Given,
Amount hold in stock is $1,000.
Rate of inflation is 10%.
The formula to calculate inflation tax is,
Substitute $1,000 for the amount of money and 10% for the rate of inflation.
The real value of inflation tax paid by Ms. Maria is $100.
b. Real inflation tax paid by Ms. Maria for the second year.
Given,
Amount at the beginning of the second year is $900.
Rate of inflation after two years is 10.1%.
The formula to calculate inflation tax is,
Substitute $900 for the amount of money and 10.1% for the rate of inflation.
The real value of inflation tax paid by Ms. Maria for the second year is $90.9.
c. Real inflation tax paid by Mrs. Maria for the third year.
Given,
Amount at the beginning of the third year is $809.1.
Rate of inflation after three years is 10.21%.
The formula to calculate inflation tax is,
Substitute $809.1 for the amount of money and 10.21% for the rate of inflation.
The real value of inflation tax paid by Mrs. Maria for the third year is $82.6.
d. Cumulative real inflation tax paid.
Given,
Tax for the first year is $100.
Tax for the second year is $90.9.
Tax for the third year is $82.6.
The formula to calculate cumulative inflation tax paid is,
Substitute $100 for the tax for the first year, $90.9 for the tax for the second year and $82.6 for the tax for the third year.
The cumulative inflation tax paid is $273.5.
e. Inflation tax when the inflation rate is 25%.
Real inflation tax for the first year
Given,
Amount hold in stock is $1,000.
Rate of inflation is 25%.
The formula to calculate inflation tax is,
Substitute $1,000 for the amount of money and 25% for the rate of inflation.
The real value of inflation tax paid by Mrs. Maria is $250.
Real inflation tax for the second year.
Given,
Amount at the beginning of the second year is $750.
Rate of inflation after two years is 25.25%
The formula to calculate inflation tax is,
Substitute $750 for the amount of money and 25.25% for the rate of inflation.
The real value of inflation tax paid by Mrs. Maria for the second year is $189.375.
Real inflation tax for the third year.
Given,
Amount at the beginning of the third year is $560.625.
Rate of inflation after three years is 25.525%
Hyper-inflation is such a big problem because it leads to a large amount of inflation tax. The purchasing power of money decreases which certainly leads to an instability in the market.
The formula to calculate inflation tax is,
Substitute $560.625 for the amount of money and 25.525% for the rate of inflation.
The real value of the inflation tax paid for the third year is $143.09.
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