Deflation

Deflationary Spiral

-Businesses get hurt (less revenue because prices go down) -Unemployment- higher cost of production -Deferred consumption- expectations are low, people would rather save money -Investment- revenues are falling/ people consume less/ there is unemployment

Bad Deflation

• Comes from demand side of economy • A fall in AD -> decrease in price level + output • Real output decrease -> increase level of unemployment, firms need fewer workers if there is less demand

Good Deflation

• Comes from: ○ Improvements in supply side of economy ○ Increased productivity • Increase in LRAS curve -> increase in real output and fall in price level • Real output increase -> lower level of unemployment, more workers will be needed to produce the higher level of output

Costs

• Deflationary spiral ○ AD low, business lay off workers ○ Prices falling, consumers put off purchase of durable goods to wait for prices to drop further (deferred consumption) ○ Further reduces AD ○ If households become pessimistic, consumer confidence fall ○ Further reduces AD • Unemployment ○ Caused by deflationary spirals • Effect on investment: ○ During deflation, businesses make less profit or make losses ○ Companies lay off workers ○ Business confidence low, reducing investment ○ Negative implication for future economic growth • Costs to debtors: ○ For people who have taken a loan (including mortgages), value of their debts rise due to deflation ○ Makes it hard for businesses to pay back loans -> bankruptcies ○ Worsens business confidence

What is it?

• Persistent fall in the average level of prices in the economy