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Table of Contents

  1. Topic pack - Macroeconomics - introduction
  2. 2.1 The level of overall economic activity (notes)
  3. 2.1 The level of overall economic activity (questions)
  4. Section 2.2 Aggregate demand and supply (notes)
  5. Section 2.2 Aggregate demand and supply (simulations and activities)
  6. 2.2 Aggregate Demand and Aggregate Supply (questions)
  7. 2.3 Macroeconomic objectives (notes)
  8. Low Unemployment
    1. Low Unemployment
    2. What the data says
    3. The meaning of unemployment
    4. Case study - regional variation
    5. Consequences of unemployment
    6. Case study - tougher for men
    7. Types and causes of unemployment
    8. Disequilibrium unemployment
    9. Equilibrium unemployment
    10. Policies to reduce unemployment
    11. Low and stable inflation
    12. Low and stable inflation (notes)
    13. The meaning and measurement of inflation
    14. A consumer price index
    15. Finding out more about consumer price index weights
    16. Problems with measuring inflation
    17. Inflation - videos
    18. Consequences of inflation
    19. Hyperinflation
    20. The consequences of deflation
    21. Types and causes of inflation: demand-pull inflation
    22. Types and causes of inflation: cost-push inflation
    23. Case Study - car prices in Trinidad
    24. Possible relationships between unemployment and inflation
    25. PlotIT - Phillips curve
    26. Phillips curve - long-run
    27. Natural rate of unemployment
    28. NAIRU
    29. Economic growth
    30. Economic growth (notes)
    31. Causes of economic growth
    32. Economic growth and the PPF (1)
    33. Economic growth and the PPF (2)
    34. Economic growth and the business cycle
    35. Economic growth and the aggregate supply curve
    36. Consequences of economic growth
    37. Equity in the distribution of income
    38. Equity in the distribution of income (notes)
    39. Indicators of income equity
    40. Poverty
    41. The poverty line: An Indicator of Relative poverty
    42. The causes of poverty
    43. The role of taxation in promoting equity
    44. The role of taxation in promoting equity (notes)
    45. Other methods of promoting equity
  9. 2.3 Macroeconomic objectives (questions)
  10. 2.4 Fiscal policy (notes)
  11. 2.4 Fiscal policy (questions)
  12. 2.5 Monetary policy (notes)
  13. 2.5 Monetary Policy (questions)
  14. Section 2.6 Supply-side policies (notes)
  15. 2.6 Supply-side policies (questions)
  16. Print View

The consequences of deflation


Deflation is a persistent, continuous decrease in the price level or a situation in which output and employment are falling as a result of a fall in AD.

Syllabus: Discuss the possible consequences of deflation, including high levels of cyclical unemployment and bankruptcies.

The term deflation is often used in a broad sense to describe a process in which there is a fall in aggregate demand leading to lower levels of output, employment, investment and possibly profits and prices.

Costs of deflation

  • As with inflation Uncertainty is a major force against investment and while prices are falling businesses will be reluctant to put funding into investment when the real value of returns cannot be accurately estimated.
  • The problem of deflationary expectations - deflation may cause people to postpone their spending in the expectation of even lower prices in the future. When this happens, aggregate demand falls, businesses are unable to sell their goods, make profits or meet their debt repayment obligations and, as a consequence, may be forced to cut output and employment of workers. A downward spiral becomes established in which aggregate demand falls even further leading to even lower prices. As Japan has discovered in the mid-1990s, once a downward deflationary spiral sets in, it may be exceedingly difficult to reverse.
  • Deflation increases the value of real debt - with some inflation in the system, borrowers experience a fall in the real value of their debt over time. However, with falling prices borrowers will experience an increase in the real value of their debt and in such a climate, companies and individuals with debt may struggle. This in itself may exert a further twist to the downward deflationary spiral.
These are the main reasons why deflation causes high demand deficient unemployment and bancruptcies among firms.

Past Paper Essay Question

May 2012 TZ1

2. (a) Explain why governments may view deflation as a threat. [10 marks]

    (b) Evaluate the view that a low and stable rate of inflation is beneficial for an economy. [15 marks]