Inflation and Deflation

Inflation and Deflation

Inflation is the pervasive and sustained rise in the aggregate level of prices measured by an index of the cost of various goods and services. Inflation results when actual economic pressures and anticipation of future developments cause the demand for goods and services to exceed the supply available at existing prices or when available output is restricted by faltering productivity and market constraints. Inflation is most common and is defined by an increase in average prices throughout the economy. Consequently the value of money decreases because people can buy less now with the same amount as money as before. If firms are spending they are going to produce more and the economy's output will increase. Furthermore, firms are able to raise prices and profits before they pay out higher wages. Finally, from the perspective of a borrower, inflation is good because at the time of borrowing, the money will be worth more than it is when it is paid back - however the rate of interest may cancel out this benefit.

Deflation is nothing but a fall in the general price level. In order to understand the circumstances under which Deflation occurs and affects an economic condition, one needs to go through the causes of Deflation. Causes of Deflation:

* Capitalism characterized by sufficient existence of competition, is regarded as one of the factors responsible for the emergence of Deflation. In this case, with the improvement in the capital stocks, competition increases million fold. Escalation in the total number of competitors boosts up the supply of goods, indicating that the prices must decrease in order to stabilize the demand, thereby bringing in Deflation. Capitalism also brings in innovation and efficiency, which also contributes towards the initiation of Deflation.

*In an economy based on credit, a decrease in money supply results in remarkably less lending trend, followed by a sharp decline in the money supply. As a result, there occurs a sharp reduction in the demand for goods.