Inflation and deflation are two faces of the same coin per economic situation, and both have their effects on product pricing. Read the article to understand these two components affect the prices of goods during deflation and inflation in an economy.
Inflation and deflation are critical since the economy has to maintain a balance, and it may swiftly shift from one to the other. These two factors affect the whole economy and decide the prices of goods during deflation and inflation.
The Reserve Bank of India monitors price movements and manages deflation or inflation in India through monetary policy, such as interest rate setting. These two factors decide the prices of goods during deflation and inflation.
Inflation
Inflation is a quantitative measure of the rate at which the price of products in an economy. Inflation occurs when commodities and services are in high demand, resulting in a decrease in availability. Consumers are prepared to pay more for what they desire, forcing manufacturers and service providers to raise their prices.
Inflation is defined as an increase in the pricing of everyday goods and services such as housing, food, clothes, recreation, transportation, consumer staples, etc. In India, the Ministry of Statistics and Programme Implementation calculates inflation.
For example, if a kg of oranges costs ₹80 in 2019 and ₹90 in 2020, there would be a 10% rise in the cost of a kg of oranges. Similarly, various items and services whose prices have risen throughout time are grouped, and the percentage is computed using a year as the base year. The rate of inflation is the percentage increase in the prices of a collection of goods.
Inflationary Factors
Several causes contribute to inflation; here are a few examples:
The Money Supply
One of the fundamental causes of inflation is an excess of currency supply in an economy. This occurs when a country’s money supply/circulation expands faster than economic growth, lowering the currency’s value.
The National Debt
The national debt is influenced by a variety of factors, including the country’s borrowing and expenditure. When a country’s debt grows, it has two choices:
- Internal taxes can be levied.
- To pay off the debt, more money can be produced.
The Push-Pull Effect
According to the demand-pull effect, in a developing economy, individuals have more money to spend on products and services as wages rise. As demand for products and services increases, corporations will raise prices that customers will endure to balance supply and demand.
The Cost-Pushing Effect
According to this idea, when corporations confront rising input costs for raw materials and salaries when making consumer goods, they will maintain profitability by passing on the increased production costs to the end customer through higher pricing.
Rates of Exchange
An economy exposed to global markets operates mostly based on the dollar. Exchange rates are essential in influencing the pace of inflation in a global trading economy.
Inflationary Effects
When a country experiences inflation, the buying power of its citizens falls as commodity and service prices rise. The value of the currency unit falls, lowering the cost of living in the country. When the rate of inflation is high, the cost of living rises, resulting in a slowing of economic growth. On the other hand, a healthy inflation rate (2-3%) is regarded as favourable since it immediately results in increased salaries and business profitability and keeps capital moving in a rising economy.
What Is Deflation & Prices of Goods During Deflation
Deflation is defined as a drop in the price of goods and services when the rate of inflation goes below 0%. Deflation will occur organically if and when an economy’s money supply is constrained. Deflation is typically associated with high unemployment and poor levels of production of products and services. The terms “deflation” and “disinflation” are frequently interchanged. Prices of goods during deflation fall and disinflation occurs when inflation grows at a slower rate.
Uncontrolled price decreases, like out-of-control hyperinflation, can lead to a harmful deflationary cycle. This circumstance is common during times of economic crisis, such as a recession or depression, when economic activity slows and demand for investment and consumption declines. As a result, asset values may fall overall as manufacturers are compelled to dispose of stockpiles that buyers no longer want to acquire. Consumers and companies alike tend to accumulate liquid cash reserves in order to protect themselves against future financial loss.
As more money is saved, less money is spent, reducing aggregate demand even further. People’s expectations for future inflation are also lower at this stage, and they begin to hoard money. When consumers may fairly anticipate their money to have more purchasing power tomorrow, they have less motivation to spend money today.
Deflationary Causes
Deflation can be produced by a variety of reasons, including:
Capital market structural changes
When competing firms provide identical goods or services, there is a propensity to cut prices in order to gain an advantage over the competition.
Productivity has increased
Increased production efficiency is enabled by innovation and technology, resulting in cheaper pricing for goods and services. Some inventions have an influence on the productivity of specific industries as well as the overall economy.
Currency supply has decreased
The drop in money availability will lower the prices of goods and services, making them more affordable to individuals.
Deflationary Effects
Deflation can have the following economic effects:
Reduced Business Revenues
To be successful in a deflationary environment, firms have to lower the price of products or services. Revenues begin to decline when prices are reduced.
Wage cuts and layoffs
When sales begin to fall, firms must discover ways to minimise expenditures in order to fulfill targets. One method is to reduce salaries and lay off workers. This has a negative impact on the economy since customers will have less money to spend.
Conclusion
The majority of the world’s central banks aim for low inflation of 2%-3% per year. Higher levels of inflation can be hazardous to an economy because they lead goods prices to grow too rapidly, sometimes exceeding wage increases. Deflation, on the other hand, may be detrimental for an economy because it causes individuals to hoard cash instead of spending or investing in the hope that prices will soon fall even more.
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