Which situation best illustrates the effects of inflation on different groups in the economy?

• A. A worker receives a 5% raise while the overall price level is unchanged, increasing their real purchasing power.
• B. Prices for most goods fall steadily over time, increasing the real value of money and fixed incomes.
• C. Productivity rises and firms can produce more output at lower cost, causing real wages to rise without higher prices.
• D. A retiree living on a fixed pension finds that groceries and rent cost more than last year, reducing what they can afford.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the concept of inflation, which is the general increase in the overall price level of goods and services in an economy over time. Inflation reduces the purchasing power of money, meaning that each unit of currency buys fewer goods and services than before.
2. Step 2: Identify how inflation affects different groups differently. For example, workers with wages that rise faster than inflation gain purchasing power, while those on fixed incomes lose purchasing power because their income does not adjust with rising prices.
3. Step 3: Analyze each option in the problem to see if it reflects the impact of inflation. The first option describes a wage increase with no inflation, so real purchasing power increases, but this is not about inflation effects.
4. Step 4: The second option describes falling prices (deflation), which is the opposite of inflation, so it does not illustrate inflation effects.
5. Step 5: The fourth option describes a retiree on a fixed pension facing higher prices for essentials, which means their real income falls due to inflation. This best illustrates the negative effect of inflation on people with fixed incomes.