What is one impact of inflation on aggregate demand?

• A. It increases purchasing power
• B. It encourages higher production rates
• C. It may decrease consumption by eroding purchasing power
• D. It has no significant effect

Answer: (C)

Inflation typically leads to a decrease in the purchasing power of money, meaning that consumers are able to buy fewer goods and services with the same amount of money. This reduction in purchasing power can lead to decreased overall consumption, as individuals and households may find their real income diminished. Consequently, with less disposable income available, consumers may cut back on spending. This decrease in consumption directly impacts aggregate demand, as lower consumption leads to a reduction in the total demand for goods and services in the economy. Therefore, recognizing that inflation can erode purchasing power helps to understand its negative effect on aggregate demand.