Which of the following statements best explains how even low levels of inflation can negatively affect real output?

• A. Low inflation increases shoe-leather costs, causing individuals to spend more time managing cash balances, which can reduce productive activities.
• B. Low inflation has no impact on transaction costs or business planning.
• C. Low inflation eliminates menu costs, making price adjustments easier for firms.
• D. Low inflation always leads to higher real wages, increasing overall output.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of inflation and its impact on the economy. Inflation refers to the general increase in prices over time, which affects purchasing power and economic decisions.
2. Step 2: Define 'shoe-leather costs' as the increased costs of time and effort that people spend to counteract the effects of inflation, such as making more frequent trips to the bank to withdraw smaller amounts of cash to avoid holding depreciating money.
3. Step 3: Recognize that even low levels of inflation can increase shoe-leather costs because individuals and businesses try to minimize holding cash that loses value, which means they spend more time managing cash balances rather than engaging in productive activities.
4. Step 4: Analyze why other options are less accurate: low inflation does not eliminate menu costs (the costs of changing prices), nor does it necessarily lead to higher real wages or have no impact on transaction costs.
5. Step 5: Conclude that the best explanation is that low inflation increases shoe-leather costs, which diverts time and resources away from productive activities, thereby negatively affecting real output.