Which of the following is an effect of inflation that illustrates a menu cost?

• A. The government automatically collects less tax revenue because inflation reduces nominal incomes.
• B. Firms must spend more time and resources changing posted prices (e.g., reprinting menus or updating price tags).
• C. Inflation eliminates the opportunity cost of holding cash, so households hold larger real money balances.
• D. Inflation permanently increases the economy’s long-run real GDP growth rate.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of 'menu costs' in the context of inflation. Menu costs refer to the costs that firms incur when they have to change their prices frequently due to inflation. These costs can include physically changing price tags, reprinting menus, updating computer systems, and communicating new prices to customers.
2. Step 2: Analyze each option to see which one directly relates to the idea of firms incurring costs to update prices. The key is to identify the option that involves firms spending resources specifically because prices need to be changed.
3. Step 3: The first option mentions government tax revenue changes due to inflation affecting nominal incomes, which is related to tax brackets and inflation but not menu costs.
4. Step 4: The third option talks about inflation affecting the opportunity cost of holding cash, which relates to money demand and liquidity preference, not menu costs.
5. Step 5: The fourth option claims inflation permanently increases long-run real GDP growth, which is a macroeconomic growth theory issue and unrelated to menu costs. Therefore, the correct effect illustrating menu costs is the one where firms must spend time and resources changing posted prices.