Cambridge International as and a level Economics Ebook

Deflation and disinflation
Defl ation
is sometimes taken to mean a lower level of 
economic activity, which might be the result of government 
policy. Indeed, defl ationary policy measures are those 
designed to reduce aggregate demand. However, defl ation is 
now more commonly taken to refer specifi cally to a sustained 
fall in the price level. It results in a rise in the value of money, 
with each currency unit having greater purchasing power.
Defl ation involves a negative infl ation rate, for 
example, –3%. In contrast, 
disinfl ation
occurs when the 
infl ation rate falls but is still positive. For instance, the 
infl ation rate may decline from 8% to 6%. In this case, the 
price level is still rising but at a slower rate.
Deflation: 
a sustained fall in the price level.
Disinflation: 
a fall in the inflation rate.
KEY TERMS
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Cambridge International AS Level Economics
Causes and consequences of deflation
Defl ation will increase the burden of debt, may increase 
the real rate of interest and may result in menu costs. Th
e 
eff ects of defl ation are, however, heavily infl uenced by 
the cause of defl ation. Economists refer to good defl ation 
and bad defl ation. Good defl ation occurs as a result of an 
increase in aggregate supply. 
Figure 4.10
 shows an increase 
in aggregate supply resulting in a fall in the price level and 
a rise in real GDP.
Advances in technology, for instance, may create new 
methods of production and lower costs of production. As 
well as output increasing, employment may rise and the 
international competitiveness of the country’s products 
may increase.
In contrast, bad defl ation takes place when the price 
level is driven down by a fall in aggregate demand as 
shown in 
Figure 4.11.
In this case output falls, which may result in higher 
unemployment. Th
is type of infl ation runs the risk of 
developing into a defl ationary spiral. Consumers may 
delay their purchases, expecting prices to fall further in 
the future. Firms, seeing lower demand, may not invest 
and may reduce the number of workers they employ. 
Th
ese measures will reduce demand further and economic 
activity will decline again.