When inflation occurs

Question

BlackTom AI · Accepted Answer

The prompt presents a question about what happens when inflation occurs and provides four answer choices to evaluate.
Option 1: 'the purchasing power of money decreases.' This is aligned with the standard definition of inflation: as the overall price level rises, each unit of currency buys fewer goods and services, reducing purchasing power.
Option 2: 'the purchasing power of money increases.' This contradicted the fundamental effect of inflation; rising prices mean money buys less, not more, so this statement is inaccurate.
Option 3: 'all prices are rising.' While inflation involves a general rise in price levels, it does not imply that every single price increases; some prices may fall or remain unchanged due to sectoral differences, relative price changes, or idiosyncratic factors. Therefore, this statement oversimplifies inflation.
Option 4: 'each dollar of income will buy more output than before.' This runs opposite to inflation’s impact on real purchasing power; as prices rise, the same nominal income generally buys fewer goods unless income also rises proportionally, which is not guaranteed by inflation alone.

In summary, the core effect of inflation is the eroding of money’s purchasing power as the price level increases, making option 1 the one that most accurately captures the phenomenon. The other options either state the opposite effect, overgeneralize price movements, or misinterpret the relationship between income and output under inflation.

When inflation occurs

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