Effects of Deflation | A-Level Economics Model Paragraph

Disadvantage of Deflation

Deflation can be damaging, as it can trigger a deflationary spiral. Deflation is when there is a fall in the average price level. When prices first fall in the economy, people form an expectation that prices will continue to fall. Because of this expectation, consumers are likely to delay spending, as they expect big-ticket purchases like homes to be cheaper if they waited. This leads to a fall in consumer spending. This is a component of aggregate demand, so aggregate demand would decrease. The further aggregate demand falls, the further the price level will fall, therefore continuing the spiral. Another issue with deflation is that it causes the real value of debt to increase. Consumers and businesses would owe the same debt despite a fall in the value of their assets. If workers or businesses saw a fall in income or profit, they would find it harder to make their repayments. This can further damage consumer and business confidence. Overall, deflation can trigger a negative multiplier effect which can cause a recession, which is when economic growth falls for two consecutive quarters.

Advantage of Deflation

However, one advantage of deflation is that it can make UK goods and services more competitive relative to those of other countries. As prices fall, UK goods and services appear cheaper, so exports are likely to increase. As exports rise, imports are likely to seem more expensive to UK consumers. Overall, exports are likely to rise and imports are likely to fall, so the trade balance is likely to improve.

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