A succinct and complete summary of the Deflation topic of AQA A-level Economics. Using only this material when revising for the Deflation section of Paper 1 I was able to achieve an A* in Economics.
Topic: Deflation (Yr 1&2)
- Mark Carney says that a period of low inflation – even deflation – propelled by falling
oil prices would be "unambiguously good" for the economy.
- He has also said there were no signs yet of "bad" deflation.
Feb 2015
Def: A general decline in price level over a period of time
- Caused by either a decrease in AD or an increase in SRAS + LRAS
Deflation is often a sign that the economy is doing badly, as it’s usually caused by falling
aggregate demand and increased unemployment.
However, deflation can also be caused if firms’ costs fall (e.g. because of new technology)
and these benefits are then passed on to consumers in the form of lower prices.
Central banks attempt to stop severe deflation, along with severe inflation, in an attempt to
keep the excessive drop in prices to a minimum.
The opposite of demand led inflation, demand led deflation has the side effect of increased
unemployment since there is a lower level of demand in the economy, which can lead to an
economic depression.
Difference between inflation, disinflation and deflation
Inflation - In economics, inflation is a general rise in the price level in an economy over a period
of time. When the general price level rises, each unit of currency buys fewer goods and services;
consequently, inflation reflects a reduction in the purchasing power per unit of money.
Disinflation - Disinflation is a decrease in the rate of inflation
Deflation - Deflation is a general decline in prices for goods and services. During deflation, the
purchasing power of currency rises over time.
What is a deflationary spiral?
If deflation is exacerbated, it can throw an economy into a deflationary spiral. This happens when
price decreases lead to lower production levels, which, in turn, leads to lower wages, which leads
to lower demand by businesses and consumers, which lead to further decreases in prices.
Example of deflation
Japan - From 1991 through 2001, Japan experienced a period of economic stagnation and price
deflation known as "Japan's Lost Decade."
- High attitude to saving (high MPS) -
- Old demographic → many pensioners → fixed income
- Average propensity to consume is less than average propensity to save (APS>APC) →
marginal propensity to withdraw high (MPW) → large amount of leakages from circular
flow of income → negative multiplier → aggregate demand falls → fall in price level
AO4: risk for different countries
Developed countries are at much higher risks of deflation (due to inflation targeting) and
developing countries are at higher risk of high inflation.
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