Tuesday, 10 March 2009


Deflation is decreasing in the general price level.
Deflation might be caused by decreasing in the
aggregate demand (as we know aggregate demand=
consumption+government spanding+investment+
exports - imports).
From the diagram above we can see that AD decreases
and shifts to the left and price decreases from P to P1.
Possible Economic Costs of Deflation:
-Holding back on spending: Consumers may prefer to spend
money later if they expect prices to fall further in the future.
-Debts increase: People might spend less because
the real value of household, corporate and government debt
rises when the price level is falling.
-The real cost of borrowing increases: Real interest rates will
rise if nominal rates of interest do not fall in line with prices –
another factor driving spending lower.
-Lower profit margins: Company profit margins come under
pressure unless costs fall further than final prices to consumers –
this can lead to higher unemployment as firms seek to reduce
their costs. Weaker profit margins can also have a negative effect
on stock markets because of a fall in expected profits and dividends
to shareholders
-Confidence and saving: Falling asset prices such as price deflation
in the housing market hit personal sector financial wealth and confidence –
leading to further declines in AD and a rise in precautionary savings
(the average and marginal propensity to save will tend to rise).

However deflation can also be caused by an increase
in a nation's productive potential which leads to an
excess of aggregate supply over demand.
From the second diagram above we can see that long run
aggregate supply increases and shifts to the right and price
falls from P1 to P2. This increasing of LRAS might be
caused by technological improvement or increasing in
a nation's productive potential.
In this case deflation might cause an increasing in the
country's economic growth. Consumers gets the benefit
of technology and increased competition in the form of
lower prices leading to an improvement in economic welfare.


chris sivewright said...

It's nice to see at least TWO of my students are doing their homework!



I explained to them the sacrifices their parents have made and here they are, during the holidays, working hard.

You should add their blog to your list - and also do a DAILY blog.

chris sivewright said...

I hear you are back. Are you just passing through or actually staying for a short while - long enough perhaps to do your DAILY BLOG!!!!

chris sivewright said...


chris sivewright said...


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