Deflation

1
Deflation

• Chapter 13 Section 2

2
Objectives

• What is deflation?
• How is deflation measured?
• What causes deflation?
• What are the effects of deflation?

3

• Deflation
• Decrease in the price level or average level of
  prices
• How do we measure Deflation?
• Percentage change in CPI (Consumer Price
  Index)

4
How do we calculate deflation?
CPI (Later Year)
-
CPI (Earlier Year)
Deflation Rate

X 100
CPI in (Earlier Year)
5
Sample Problem
Last Year CPI 120 Current Year CPI
110 Calculate the Deflation Rate
-
110
120
Deflation Rate

X 100
120
- 10

X 100
120
- 8.3

6
Deflation caused by decrease in Aggregate Demand
Price Level
AS
P1
P2
AD
AD
Q1
Q2
Quantity
7
Deflation caused by increase in Aggregate Supply
Price Level
AS
AS
P1
P2
AD
Q1
Q2
Quantity
8
Simple Quantity Theory of Money and Deflation

• M x V P x Q .
• A decrease in price level (deflation) is caused
  by
• a decrease in the money supply .
• (Velocity Quantity held constant)
• M(400) x V(2) P(8) x Q(100 units)
• 800 800 .
• M(200) x V(2) P(4) x Q(100 units)
• 400 400 .

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Major Effects of Deflation

• Not all prices fall at the same time.
• If resource prices stay high,
• business may suffer higher total costs which
  result in lower
• total revenues.
• Therefore, they suffer lower profits.
• To counter, they lay-off workers.
• Possible going out of business

10
Assessment

• What is deflation?
• How is deflation measured?
• What causes deflation?
• What are the effects of deflation?