Deflation refers to the decrease in the average price level of good and services. It is measured by a decrease in the Consumer Price Index. It happens when the rate of inflation becomes negative i.e. below 0%. In other words, it is defined as a general decrease in consumer prices and assets but the increase in the value of money. It occurs during a deep recession when there is a sustained fall in economic output and demand.
Aggregate demand (AD) is a measure of the amount of goods and services that will be purchased at various prices which shows the quantities of real domestic output (Guell, 2012). Deflation is sparked by an increase in supply and also tend to happen when the economy’s capacity, as indicated by the position of the Aggregate Supply (AS), grows at a faster rate than aggregate demand (AD). In this situation, firms have to cut their product prices in order to stimulate sales and get rid of stocks. In another side, aggregate demand falls and results in a recession when the business and consumer confidence in the economy declines.
Deflation is caused by the fall in aggregate demand which in turn lower price level. Aggregate demand directly affects aggregate employment and output. The reduction in aggregate demand reduces output because of firm’s ability to sell output declines after aggregate demand fall and they, therefore, cut production to serve their own interest (Fazzari, Ferri, & Greenberg, 1998). There are several reasons for the fall in aggregate demand. If the government cut the wages of public sector workers and cut spending then it creates fiscal austerity which provokes to fall in spending and eventually the aggregate demand falls. Secondly, while in a serious recession, people expect a bad outcome about the future that leads to cut back on spending and increase their personal savings. This paradox of thrift causes lower demand where a firm again has to try and cut prices to encourage sales. Thirdly, the tight monetary policy and overvalued exchange rate and high-interest rates also cause a fall in aggregate demand.
References
Fazzari, S. M., Ferri, P., & Greenberg, E. (1998). Aggregate demand and firm behavior: A new perspective on Keynesian microfoundations. Journal of Post Keynesian Economics, 20 (4), 527-558.
Guell, R. C. (2012). Aggregate Demand and Aggregate Supply. In R. C. Guell, Issues in Economic Today (sixth ed., pp. 100-101). New York, United States: McGraw-Hill.
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Deflation refers to the decrease in the average price level of good and services. It is measured by a decrease in the Consumer Price Index. It happens when the rate of inflation becomes negative i.e. below 0%. In other words, it is defined as a general decrease in consumer prices and assets but the increase in the value of money. It occurs during a deep recession when there is a sustained fall in economic output and demand.
Aggregate demand (AD) is a measure of the amount of goods and services that will be purchased at various prices which shows the quantities of real domestic output (Guell, 2012). Deflation is sparked by an increase in supply and also tend to happen when the economy’s capacity, as indicated by the position of the Aggregate Supply (AS), grows at a faster rate than aggregate demand (AD). In this situation, firms have to cut their product prices in order to stimulate sales and get rid of stocks. In another side, aggregate demand falls and results in a recession when the business and consumer confidence in the economy declines.
Deflation is caused by the fall in aggregate demand which in turn lower price level. Aggregate demand directly affects aggregate employment and output. The reduction in aggregate demand reduces output because of firm’s ability to sell output declines after aggregate demand fall and they, therefore, cut production to serve their own interest (Fazzari, Ferri, & Greenberg, 1998). There are several reasons for the fall in aggregate demand. If the government cut the wages of public sector workers and cut spending then it creates fiscal austerity which provokes to fall in spending and eventually the aggregate demand falls. Secondly, while in a serious recession, people expect a bad outcome about the future that leads to cut back on spending and increase their personal savings. This paradox of thrift causes lower demand where a firm again has to try and cut prices to encourage sales. Thirdly, the tight monetary policy and overvalued exchange rate and high-interest rates also cause a fall in aggregate demand.
References
Fazzari, S. M., Ferri, P., & Greenberg, E. (1998). Aggregate demand and firm behavior: A new perspective on Keynesian microfoundations. Journal of Post Keynesian Economics, 20 (4), 527-558.
Guell, R. C. (2012). Aggregate Demand and Aggregate Supply. In R. C. Guell, Issues in Economic Today (sixth ed., pp. 100-101). New York, United States: McGraw-Hill.