The phrase, a decline in the average price level over a sustained period, describes which of the following term
A. Deflation
B. Inflation
C. Disinflation
D. Economic growth
The correct answer and explanation is:
The correct answer is A. Deflation.
Deflation refers to a decrease in the general price level of goods and services over a sustained period. It occurs when there is a reduction in the supply of money or a decrease in demand for goods and services in the economy, leading to lower prices. While inflation is the opposite, indicating an increase in prices, deflation can have significant effects on an economy.
One of the primary causes of deflation is a drop in demand, often driven by factors like reduced consumer spending, economic recessions, or a contraction in the money supply. For example, if consumers are unsure about the economy’s future, they may cut back on spending, leading to a decrease in the demand for products. As demand decreases, businesses may lower their prices to stimulate purchasing, contributing to deflation.
Deflation can be harmful because it leads to a cycle of reduced consumer spending and investment. As prices fall, consumers may delay purchases in the hope that prices will fall further, which in turn reduces overall demand in the economy. Additionally, businesses may see lower profits, leading them to cut costs by reducing wages or laying off workers, which further exacerbates the economic downturn.
In contrast, inflation is when prices increase over time, while disinflation is a reduction in the rate of inflation, meaning prices are still rising but at a slower pace. Economic growth refers to an increase in the production of goods and services in an economy, which is usually associated with rising living standards and employment.
Deflation, if severe and prolonged, can lead to a deflationary spiral, a dangerous economic situation where decreasing prices lead to lower economic output and rising unemployment. This is why central banks generally aim to keep inflation at a low and stable level rather than allowing deflation to occur.