Deflation

Question 1

What is deflation?

Answer 1

Deflation is the persistent fall in prices in an economy in a year. This is when the inflation rate is negative.

Question 2

When does demand side deflation occur and why is it bad deflation?

Answer 2

Occurs when AD shifts left.

It comes with lower growth.
Deflation is also assumed to be long term and anticipated. If a recession occurs as a result, they last long and so will deflation

Question 3

When does supply side deflation occur and why is it good deflation?

Answer 3

Occurs when SRAS shifts right.

It comes with higher growth.
Deflation here assumed to be short term and unanticipated. This is because fops always change in terms of like costs.

Question 4

What are the dangers of anticipated deflation?
(Demand Side)

Answer 4

1) Delayed spending by rational consumers. They may delay consumption thinking prices will continue decreasing. Firms slash prices to make sales. This will lead to a deflationary spiral. The worst consequence is lower AD, lower growth, unemployment, etc

3) Increases real value of debt. As pric falls, profits and income fall. This makes it harder to pay back debt. Consumers and businesses will be unable to take on more debt. This will result in more deflation as AD falls further. More unemployment, lower incomes,etc

Question 5

What are the benefits of short term unanticipated deflation?
(Supply side)

Answer 5

1) Falling prices for consumers. Theres increased purchasing power for them.

2) Falling prices for inputs. This reduces costs meaning higher profits.

Question 6

Evaluation points for deflation?

Answer 6

1) Anticipated deflation is very bad where as unanticipated isnt.

2) Causes. Supply side not as bad