Guell (2015), in their book Issues in Economics Today, deflation is that destructive cycle in the economy majorly prevails when the average price level persistently fall. The cause of deflation is generally credited to bad government policies. Such kind of economic situation is rare and must be avoided because it considered as a deadly spiral from which nation can hardly recover.
Aggregate demand is simply the sum or total demand for products and services of the entire economy. It shows the relationship between the aggregate level of price and quantity demanded and output of the businesses, households, government and the rest of the world. Normally, it depicts the gross domestic product of the country or of the economy. Following is the graphical representation of aggregate demand curve.
The formula for aggregate demand is
AD = C + I + G + (X - M)
Where,
Consumption = C,
Investment = I,
Government Spending = G,
X = Exports &
M = Imports
Consequences of deflation in terms of Aggregate Demand
There are two main potential causes of deflation:
A fall in aggregate demand (AD)
A shift to the right of aggregate supply (AS) - i.e. lower costs of production through improved technology.
1. A fall in aggregate demand (AD)
Figure a: Deflation caused by falling aggregate demand (AD)
Here, in above figure, PL = Price Level, LRAS = Long-run aggregate supply curve, AD =Aggregate Demand, and Y = Real GDP. This simple AD/AS model shows that a fall in AD can cause a lower price level. Deflation usually occurs during a deep recession, when there is a sustained fall in demand and output.
2. A shift to the right of aggregate supply (AS)
Figure b: Deflation caused by lower costs
Here, in above figure, PL = Price Level, SRAS = Short-run aggregate supply curve, AD =Aggregate Demand, and Y = Real GDP. This is deflation caused by lower costs of production. This could be due to lower oil prices or improved technology, e.g. development of computer chips which enables price of manufactured goods to fall.
For instance; 1920s Japanese Deflection was the example for deflection, and the reasons are the massive injection of public funds by indemnifying against the losses of the central bank, and structural reforms in the banking sector through the promotion of bank amalgamation and other measures of that sort (Shizume, 2012).
References
Guell, Robert C. (2015). Issues in Economics Today , 7th edition- 2015 ISBN: 978-0078021817
Shizume, M. (2012). The Japanese economy during the interwar period: instability in the financial system and the impact of the world depression. In The Gold Standard Peripheries (pp. 211-228). Palgrave Macmillan, London.
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Guell (2015), in their book Issues in Economics Today, deflation is that destructive cycle in the economy majorly prevails when the average price level persistently fall. The cause of deflation is generally credited to bad government policies. Such kind of economic situation is rare and must be avoided because it considered as a deadly spiral from which nation can hardly recover.
Aggregate demand is simply the sum or total demand for products and services of the entire economy. It shows the relationship between the aggregate level of price and quantity demanded and output of the businesses, households, government and the rest of the world. Normally, it depicts the gross domestic product of the country or of the economy. Following is the graphical representation of aggregate demand curve.
The formula for aggregate demand is
Where,
Consequences of deflation in terms of Aggregate Demand
There are two main potential causes of deflation:
A fall in aggregate demand (AD)
A shift to the right of aggregate supply (AS) - i.e. lower costs of production through improved technology.
1. A fall in aggregate demand (AD)
Figure a: Deflation caused by falling aggregate demand (AD)
Here, in above figure, PL = Price Level, LRAS = Long-run aggregate supply curve, AD =Aggregate Demand, and Y = Real GDP. This simple AD/AS model shows that a fall in AD can cause a lower price level. Deflation usually occurs during a deep recession, when there is a sustained fall in demand and output.
2. A shift to the right of aggregate supply (AS)
Figure b: Deflation caused by lower costs
Here, in above figure, PL = Price Level, SRAS = Short-run aggregate supply curve, AD =Aggregate Demand, and Y = Real GDP. This is deflation caused by lower costs of production. This could be due to lower oil prices or improved technology, e.g. development of computer chips which enables price of manufactured goods to fall.
For instance; 1920s Japanese Deflection was the example for deflection, and the reasons are the massive injection of public funds by indemnifying against the losses of the central bank, and structural reforms in the banking sector through the promotion of bank amalgamation and other measures of that sort (Shizume, 2012).
References
Guell, Robert C. (2015). Issues in Economics Today , 7th edition- 2015 ISBN: 978-0078021817
Shizume, M. (2012). The Japanese economy during the interwar period: instability in the financial system and the impact of the world depression. In The Gold Standard Peripheries (pp. 211-228). Palgrave Macmillan, London.