You must have heard the terms inflation and deflation so many times. What are they? And which one is good for us? What are the causes?
In economics, inflation and deflation are the most common terms. They are two sides of the economy. Every country tries to maintain a balance between them. Let’s see what is the difference between inflation and deflation.
What is the difference between inflation and deflation
Difference between inflation and deflation
What is the difference between inflation and deflation
What is inflation?
Inflation happens when the prices of goods and services increase. It reduces the purchasing power of money. For example, suppose 10 years ago, you could buy a movie ticket for Rs 50. Now it costs 150 Rs. This is due to inflation. Money has lost its value. To measure inflation, we use the consumer price index (CPI) method. It measures the change in prices over time in a fixed market basket of goods and services.
Consumer price index = (cost of the market basket in a given year) x 100
(cost of the market basket in base period)
Causes of inflation
- Demand-pull effect:
When the supply of goods and services is less and their demand in the market is high. As a result, their prices increase.
- Cost-pull effect:
when the prices of raw material required for a product increases. Companies increase the price of a product, to gain profit. For example, if the price of wood or steel increases, furniture will also become expensive.
- Money supply:
Money supply means the total amount of money in circulation. If it is more than the rate of production, it causes inflation.
- Devaluation:
It means reducing the value of a currency than another nation. It increases the cost of imported products more than domestic goods.
Advantages of inflation
- A moderate level of inflation helps in adjusting wages.
- It also adjusts prices. It helps products to gain their real prices.
- As the money has lost its value, debtors can pay their loans.
- A positive inflation rate can boost economic growth.
Disadvantages of inflation
- The money you save also loses value due to inflation.
- Inflation causes uncertainty and confusion. People hesitate to buy things because of high prices.
- Due to inflation, government bonds lose value. Thus investors tend to invest less. This affects national growth in the long term.
- If the inflation rate of a country is more, its exports will become less competitive.
What is deflation?
Deflation happens when prices of goods and services fall. It raises the purchasing power of the money. For example, suppose the price of a product is Rs 100, people do not buy it. Then the company reduces its value to Rs 70. But people wait for prices to fall again. Then the company reduces its price to Rs 50.
Causes of deflation
- Increased productivity:
Production of goods is increasing as technology is evolving day by day. It costs less than handmade things. Thus deflation occurs.
- Shortage of money supply:
When there is not enough money in circulation, the value of money increases. It causes deflation.
Advantages of deflation
- Deflation is good for consumers as purchasing power money is more.
- The value of money is more. Thus savings will have more value.
- It is good for lenders because deflation increases the real value of debt.
- Due to deflation, the cost of raw materials, and fixed assets decrease. Hence companies tend to do long-term investments.
Disadvantages of deflation
- In deflation, the prices of goods and services decrease. Companies tend to reduce their expenditures. Thus it causes a lower production rate, and unemployment.
- Investors face losses because of the fall in the value of assets.
- People have a hard time paying off their debts.
- People wait for prices to fall in the future. This causes a lower consumption rate.
- Deflation leads to lower economic growth.
Difference between inflation and deflation
| Sr. no. | Basis of differentiation | Inflation | Deflation |
| 1 | Definition | Inflation happens when prices of goods and services progressively increase. | Deflation occurs when prices of goods and services decrease. |
| 2 | Causes | The purchasing power of money decreases | The purchasing power of money increases |
| 3 | Supply of goods and services | Low | Excess |
| 4 | The demand of goods and services | Excess | Low |
| 5 | Impact on National Income | No | Decreases |
| 6 | Price of gold | Decreases | Increases |
| 7 | Supply of money | more | less |
| 8 | Effect on consumers | Not good for consumers as purchasing power money is less | good for consumers as purchasing power money is more. |
| 9 | Employment | High chances of increase in employment. | Deflation can result in unemployment |
| 10 | Consequences | The distribution of income is unequal | The distribution of income is equal |
In this article, we discussed what is the difference between inflation and deflation. They both are equally important for the nation’s economic growth. Inflation happens when prices fall. And when prices increase, deflation occurs.
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