‫االسم‪ :‬عمر ثروت محمد ربيع محمود اسماعيل‬

‫‪English section‬‬

‫‪Topic No. : 4‬‬

‫‪Deflation‬‬
 Preface

It is obvious that we live in a world with a high degree of uncertainty. Most of the
time people fail to understand how some economic phenomena can affect the
world around us and dramatically change the way we live.
Without good understanding of economics in general and these phenomena
particularly uncertainty increases in the society and decision making becomes an
extremely hard process.
One of these phenomena is deflation. In the next few pages, we are going to dive
into deflation more deeply and discuss the following points:
 What is deflation?
 How deflation is calculated?
 Why does deflation occur?
 Is it bad?
 Who benefits from deflation?
 Who loses when deflation occur?

What is deflation?
Firstly, we have to come up with a definition of what exactly deflation is
Deflation is when the prices of goods and services fall. This gives consumers more
purchasing power because the money they have can now buy more than it
previously could. Deflation is the opposite of inflation, which is the rate at which
the costs of goods and services rises over time. When inflation rises, the value of
the dollar goes down because consumers cannot buy as much as they previously
could.
 How deflation is calculated?
In the United States, the official calculation of deflation is done by the U.S.
Department of Labor's Bureau of Statistics (BLS). The BLS surveys the prices of
goods throughout the U.S. and compares the data it collects. If the price index is
lower now than it was previously, it is considered deflation.
Here is the formula used to calculate the rate of deflation:
The price index of last year (x) - The price index of this year (y) divided by the
price index of last year (x)
Written out in a math problem, it looks like this: x - y / x.

Why does deflation occur?

Deflation is caused by several factors, including a fall in consumer demand for
goods and services. When shoppers aren't spending as much as they were in the
past, prices start to fall to encourage more spending. A drop in consumer spending
can be attributed to a variety of issues, including a decrease in the amount of
disposable income and consumers' confidence in their financial future.
Deflation can also be caused by a decrease in the money supply or an increase in
the supply of goods.
The causes of deflation go back to supply and demand. When the demand for
goods and services goes down and the supply increases, it causes deflation.
Another term that is often used for deflation is negative inflation.
One cause of a decrease in demand for goods and services is an increase in interest
rates. When consumers see interest rates rise, they are less likely to want to spend
their money. They lean more toward saving than spending and, in turn, buy less.
That means the demand goes down.
In cases similar to what we live nowadays amid covid-19 crisis when consumers
are feeling negative about their financial future, they are also less likely to buy
things, especially if these things are considered wants rather than needs.
Deflation can also happen due to an increase in supply. Some causes of increased
supply are increased technology and lower production costs. When suppliers can
produce an item at a lower cost, they tend to manufacture more of that item,
resulting in a large supply. When consumers are buying less and there is an
increase in supply, the prices of items must drop to encourage people to buy.
Advances in technology help to increase production because items are easier and
cheaper to make. This causes the supply to increase, which often drives the prices
down so consumers will purchase more.

Is deflation bad ?
This general decrease in prices is a good thing because it gives consumers greater
purchasing power. To some degree, moderate drops in certain products, such as
food or energy, even have some positive effect on increasing nominal consumer
spending. Beyond these basic staples, a general, persistent fall in all prices not only
allows people to consume more but can promote economic growth and stability by
enhancing the function of money as a store of value and encouraging real saving.
However, under certain circumstances rapid deflation can be associated with a
short term contraction of economic activity. In general this can occur when an
economy is heavily laden with debt and dependent on the continuous expansion of
the supply of credit to inflate asset prices by financing speculative investment, and
subsequently when the volume of credit contracts, asset prices fall, and speculative
overinvestments are liquidated. This process is sometimes known as “debt
deflation.”
So, the bottom line is a small decline in prices of some goods is good. however, a
genral deflation that covers all sectors of the economy is extremely bad.

Who benefits from deflation?

The people who benefit from deflation are those that are harmed by inflation.
These people are.
 Fixed-wage earners.: Deflation causes prices to go down, increasing buying
power for consumers. A fixed-wage earner essentially gets more income
despite their income not changing. Or, real value increase
 Exporters: Lower costs for production inputs mean that an export business
can price their products lower, making them more competitive on the world
market.

 Savers. Same with fixed-wage earners, the lower prices mean that the real
value of savings has increased. Essentially — the savings can buy more
goods and services.

Who loses when deflation occur?

 Borrowers: during deflation due to the increase in the value of money
borrowers' debts will worth more than its value before deflation.

 Businesses and producers: When producers are forced to cut prices below
the cost of an item, businesses lose money. The low prices resulting from
deflation may be good for consumers, but if the prices drop too low, it is bad
for producers.