Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What effect can be induced by a decrease in real income due to inflation?

1. Greater consumer spending

2. Increased business investment

3. Increased wealth inequality

4. Simplified consumer decision-making

The correct answer is: Increased wealth inequality

A decrease in real income due to inflation typically leads to increased wealth inequality. When inflation rises, the purchasing power of consumers diminishes, meaning that individuals earn the same nominal income but can afford less in terms of goods and services. This disproportionally affects those on fixed incomes or lower incomes, as their financial situation does not adjust as quickly or effectively as others who may have assets that appreciate with inflation, such as real estate or equities. Wealth inequality can increase because wealthier individuals often have a diverse range of income-generating assets that can outpace inflation, thereby preserving or even enhancing their purchasing power. Conversely, lower-income households, which generally have fewer assets and rely more heavily on wages, feel the pinch of inflation more acutely, leading to a widening gap between the affluent and those with less wealth. The other choices do not align with the effects of reduced real income due to inflation. Greater consumer spending, for instance, would typically occur when people feel more financially secure; inflation diminishes that security. Increased business investment is often curtailed in uncertain economic conditions, and simplified consumer decision-making does not naturally follow from decreased real income as consumers tend to become more cautious and analytical about their spending when facing financial strain.