What is deflation?

What is deflation?

In economic terms deflation is occurring "when prices are declining over time. This is the opposite of inflation; when the inflation rate (by some measure) is negative, the economy is in a deflationary period."

The inflation occurs when money becomes relatively less valuable than goods. Then deflation is simply the opposite, that over time money is becoming relatively more valuable than the other goods in the economy. Following the logic of that article, deflation can occur because of a combination of four factors:

1. The supply of money goes down.
2. The supply of other goods goes up.
3. Demand for money goes up.
4. Demand for other goods goes down.

Deflation generally occurs when the supply of goods rises faster than the supply of money, which is consistent with these four factors. These factors explain why the price of some goods increase over time while others decline. Personal computers have sharply dropped in price over the last fifteen years. This is because technological improvements have allowed the supply of computers to increase at a much faster rate than demand or the supply of money.

Why does deflation happen?
A fall in spending -- it could be personal spending or a cut in government expenditure -- leads to deflation. The decline in the supply of money and credit thus leads to deflation.
So, if money-supply decreases; supply of other goods increases, demand for money rises, and the demand for other goods slips, it is deflation.
So, if money-supply decreases; supply of other goods increases, demand for money rises, and the demand for other goods slips, it is deflation.
Why is it bad for the economy?
Deflation is a fall in the price of goods and services. Deflation occurs when the inflation rate falls below zero per cent. This is the opposite of inflation.
When the inflation rate is negative, the economy is in said to be in a deflationary period.
Consequences of deflation?
Deflation leads to a lower level of demand in the economy. It increases the real value of money. It also increases unemployment.
The main effect of deflation is that it gives people a huge incentive not to buy goods. This means that if something costs Rs 100 today, it will cost only Rs 95 next week, thus making people hold off their purchases. The good news is that gives people an incentive to save money.
But as fewer people buy, manufacturers are left with excess inventory. That means they need to reduce their supply, which means they can either stop manufacturing, which causes factory closures and layoffs, or they can reduce prices even further. But the latter causes even more deflation, leading to lower spending, leading to more deflation. Once an economy is caught in this deflationary spiral, it is very hard to climb out. That's why many economists are more worried about present deflation rather than inflation.
Deflation also slows down business development as entrepreneurs are less likely to invest in new business plans if they see a trend towards lower profit margins. As noted in a earlier post, deflation is more of a hinder to a strong economy than inflation.
According to Goldman Sachs, in a deflationary environment, those sectors with a high proportion of variable costs are likely to benefit from falling input prices, Effect of deflation?
The prices may fall in deflation, so is it good?
Is deflation good for you as prices may drop?
A fall in the prices may sound good for consumers. But it is not actually good. The lack in demand may push companies to further lower prices.
This can lead to a situation where the prices of product fall below the cost of manufacturing a product. This in turn forces the companies to cut production, slash jobs and shut down business till demand picks up. This worsens the situation.
EXPECTED DURATION OF DEFLATION IN INDIA
The Deflation is not likely to last long. The monetary and fiscal stimulus measures of the government is likely to boost demand in the long run. In 2010, however, Goldman Sachs expects inflation to come back due to both a gradual pick-up in demand, and conversely, a low base from 2009.