What is Deflation?

Intro

If there is a gradual decline in the price of goods commodities,then the economy is considered good. It is considered a good situation for both buyers and investors. 

But what if the price of goods comes down drastically? This type of situation is worst for the economy and called 'Deflation'. 

To understand this in simple words.

Let's get in-

What is deflation?

Pic Source-Pixabay

The state of the economy in which the inflation (see Inflation) rate Falls below zero is called deflation. In general language the deflation is a decline in prices of goods and services. Any decline in the rate of inflation should not be understood as deflation,as most people think that rate of decrement of inflation is deflation. This is incorrect. Because for ex. when inflation rate changes from 8 % to 4% ,inflation is still active in it. This is not deflation at all. 

Deflation will be called only when this rate goes into negative.( Means when this rate changes from 8% to -5% ).

As is opposite of Inflation because, inflation shows gradually 'increment' in prices while deflation shows drastic 'decline' in price of goods and services. 

Causes of deflation 

There are certain reasons of deflation. Few of them are discussed below.

1. Decrement in money flow in market.

Suppose there is ₹100Cr in regulation among 100Cr people of the nation. Everything is going well. But what if there is a curb on regulation of money and now there is only 50Cr among these 100Cr people? 

Obviously, this situation will make people miser because they don't have money to spend. Under this scenerio, Any company (say PUMA) selling a pair of shoes at ₹1200 rupees will try to sell its a pair of shoes at rupee 800 at first. But if the customer has not that amount of money this company will have to sell it at much cheaper rate maybe at 400 and 500. Consequently Company will have to shut if it fails to get the money equal to the cost of product. 

2.Increase in interest rates

The most important reason which is responsible for deflation. Any increment in the rate of interest will make unable the people to take loan from Bank. For example the home loan at 10% instead of 5% will bar people from raising loans from banks at such a high rate. Which in turn will create the situation of deflation. 

3.Decrement in demand

A sudden drop in demand is also an important reason for deflation. This can be understood with the example that the company selling the product which is not in demand will not be purchased by customer at any cost. The company may reduce its price to zero(giving the product free of cost to the customer), Creating the Loss situation for the company to survive. Making environment for deflation ready.

4.Surplus production or supply 

When any company increases its productivity it means less number of inputs will be required to get same number of outputs. Means not much time/effort/cost is required by company to get output. In a competitive market companies will reduce price of the product in order to get more customers and when the prices decline obviously, it will create a deflation environment.

Effects of deflation

1.Lower wages & high unemployment 

As the time of very less demand comes, businesses become unable to sell as much as they did before. Consequently the companies get rid of extra employees which leads to unemployment. The businesses which find difficult to lay off their workers, cut off the wages of employees.

2. Reduction in investment

Investors are affected by deflation as when we look at the variable income investors(say equity holders) will lose their money because of falling in income is fall in prices. While investors (like debentures,corporate bonds) will have no impact because their incomes are constant when prices fall.

3. Consumers will save more money

Deflation affects consumers in a positive way. Because they can purchase the costly item/product at very low price allowing  them to save their more money. In other words the deflation enhances the purchasing power of people.

How can deflation be controlled?

1.Reducing interest rates

By reducing the interest rate more investments can be stimulated easily,which will help to eradicate the deflation.

2.Lowering the taxation 

In order to remove burden of levied taxes on goods and services there should be a changed taxation policy leading to increase the purchasing power of people which in turn will enhance demand, helping to eradicate deflation in this way.

3.Regulation of production

 

There should be a perfect balance between production and demand in order to avoid any kind of over production which will help to eradicate deflation.

Because we know that any kind of imbalance in these factors easily create situations of deflation.

Our Popular posts

What is mutual fund?

The money you have invested. . .

What is Currency Chest?

These are the stocks decided by. . .

Hey, if you like this articles and wanna get more such articles, then please visit, follow,share, and subscribe to Biz Maestro.