Deflation

Costs of deflation...

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Both causes of deflation result in a fall in the price level, but we can say that the first is positive because it results i an increase in real output and a fall in unemployment, while the second cause is negative because it results in a fall in real output and a rise in unemployment.

Definition of Deflation

Deflation is a persistent fall in the average level of prices in an economy.

1. Unemployment

If the aggregate demand is low then businesses will likely lay off workers. And this will lead to deflationary spiral. This could lead to deferred consumption: When prices are falling consumers will put off the purchase of any durable goods as they will want to wait even more until the prices will fall further more. This will reduce aggregate demand. Consumer Confidence will fall, lowering the aggregate demand, deflationary spiral will occur!

Two types of Deflation 1. Good deflation

Improvements in the supply side of the economy and/or an increased productivity. An increase in the long run aggregate supply curve can result in an increase in real output and a fall in the price level. if the level of real output increases then we can assume that there is a lower level of unemployment as more workers will be needed to produce the higher level of output.

Two types of Deflation 2. Bad Deflation

Source of the demand side of the economy. aggregate demand or aggregate supply curve will illustrate that a fall in the aggregate demand will result in a decrease in the price level and a decrease in the real output. if real output decreases then it is assumed that the level of of unemployment will rise, as firms will need fewer workers if there is less demand.

2. Effect on Investment

When there is Deflation, there will be more losses for businesses and less profits. This will lead them to lay off workers. Low business confidence will appear, resulting in reduced investment, this will have a negative impact on future economic growth.

3. Costs to Debtors

anyone who has taken a loan, suffers as a result of deflation because the value of their debts will rise from deflation. When low profits, this will lead to difficulty for businesses to pay back their loans and there may be bankruptcies. this will worsen businesses confidence.