Deflation is a situation when the inflation rate becomes negative i.e. it is exactly opposite situation of inflation. This PPT gives and explanation of the causes of inflation considering both demand and supply sides of the economy.

1. Analysis of deflation

2. introduction
• Deflation is a situation when price level falls steadily or consistently
• It is different from disinflation
• Deflation can be considered as a negative rate of inflation i.e. inflation
rate falls below zero
• It causes an increase in the purchasing power of consumers by
increasing the real value of money

3. Causes of deflation
• Demand side-
Given the aggregate supply a decline
in aggregate demand (negative
demand shock) can cause a decline
in price level
In this figure the aggregate supply
curve is AS, decrease in Agg DD is
represented by a leftward shift of DD
curve from AD to AD1.
Equilibrium shifts from E to F
Price level falls from OA to OB

4. Factors Reducing Demand
• A tight monetary policy adopted by the central
bank
• Increase in direct tax by the government
• Decline in income of the consumers
• Decline in public expenditure
• Decline in demand for the country’s export from its
trading partners
• Any type of non economic factor like war, famine or
any type of natural calamity

5. Supply side factors
• Given the demand an increase in
aggregate supply (positive supply
shock) can cause deflation as
shown in this figure.
• Initial equilibrium is E and price
level is E, by the interaction of AD
and AS
• Increase in agg SS is represented by
shift of SS curve from AS to AS1.
Equilibrium moves from E to F and
price level would fall from OH to
OG

6. Factors behind supply rise
• An increase in productivity (due to technological
progress or more investment)
• Decrease in rate of indirect taxes

7. Conclusion and Policy
Prescription
• Both demand and supply shocks can cause deflation
• A deflation caused by demand shock has negative impacts as it causes
reduction in output and employment and hence aggravates the
unemployment situation which brings about recession.
• A deflation caused by a supply shock is always better as it increases the
value of money and secures more output and employment. The level of
unemployment falls
• In case of supply shock the state need not bother but during the deflation
caused by demand shock the state should intervene. Under this situation
the government has to adopt aggregate demand management policies.