Discuss whether deflation or inflation is a more serious problem for the economy

Discuss whether inflation or deflation is a more serious problem for an economy (12)

To begin with we need to define the terms inflation and deflation. The term inflation is defined as a general and sustained rise in prices. The term deflation is opposite to this and is defined as a reduction in the general level of prices sustained over several months, usually accompanied by declining employment and output.

An advantage of inflation for an economy can be it helps smaller firms grow larger. This is beneficial to the economy as it helps unemployment to reduce and increases morale for those smaller firms.

Inflation will help firms and individuals who have built up debts as the rate of interest does not fully compensate for the increase in the general price level. This ultimately leads to the real level of debts falling therefore debts become more manageable.

A disadvantage of inflation for an economy is a possible loss of competitiveness. For example, if the UK has a higher inflation rate than the rest of the world, its price competitiveness in international markets will fall. A rise in a country’s relative inflation rates may lead to a fall in its world share of exports and a consequent rise in import penetration. This ultimately leads to a fall in the rate of economic growth and the level of employment.

Another disadvantage of inflation for any economy is the inefficiency of the allocation of resources. When inflation is high, it ...

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Another disadvantage of inflation for any economy is the inefficiency of the allocation of resources. When inflation is high, it is unlikely to give companies sufficient information on rapidly changing price levels so companies will not be making informed decisions and choices. Wrong decisions may cause a business to fail.

A final disadvantage of inflation is that consumers and businesses on fixed incomes can see the real value of their income fall each year. This makes businesses or individuals poorer and reduces their ability to buy goods or services.

A decline in the level of prices can be seen as an advantage for the economy as when these prices are lower, people are going to buy more goods and services. When these prices are back to normal what was once a luxury good or service may now be seen as a necessary good or service due to the deflation previously.

Some times an economy can experience the ‘right kind of deflation’. The right kind of deflation involves lower prices through increased productivity and better technology. This can be an economical advantage because the development of new technologies increased economic activity and can help grow the economy.

Deflation will cause problems for those who have debt as they will see the real value of their debt increase. This will lead to lower consumer confidence and activity resulting in lower economic growth. If the real values of debts are high; people will feel the need to wait for the economy to become stable again, resulting in a reduction in the amount of money being put back into the economy.

Prices fall in a deflating economic environment. People become reluctant to spend money because they believe that prices will be cheaper in the future, therefore, they keep delaying purchases. This is destructive for the economy as people delay spending which can lead to the failure of firms and businesses of individuals.

A final disadvantage of deflation is that it is very hard to set prices when general prices are constantly falling. This could lead to unemployment and reduced economic activity.

To conclude, from the advantages and disadvantages of both inflation and deflation, I think that deflation is a more serious problem for the economy then inflation. Deflation is very destructive to economic activity paralysing a firms ability to create wealth and job opportunities. A relatively modest level of inflation allows the economy to move forward smoothly and creates an economic environment in which firms and individuals can prosper.

Peer Reviews

Here's what a star student thought of this essay

groat

6th of Mar 2012

Quality of writing

This essay has a strong structure. I particularly liked how the introduction defines the key terms, as this allows for a sharp argument. The style can be a bit repetitive at times, with paragraphs starting "A disadvantage" or "An advantage". I would advise not using the first person in an essay, as it suggests the argument is more opinion based rather than backed with evidence. Instead of "I think that" try and use "It is clear that" or "Evidence suggests" to secure your argument. Spelling, punctuation and grammar are fine here.

Level of analysis

The analysis is good in places, but in others it jumps to conclusions too quickly. For example "An advantage of inflation for an economy can be it helps smaller firms grow larger" is not explained whatsoever. From reading that sentence, I cannot see any understanding from the essay of why inflation facilitates smaller firms from growing larger. Simply asserting statements will get you very few marks. Similarly "This is beneficial to the economy as it helps unemployment to reduce and increases morale for those smaller firms" isn't fully explained. I would note that is essential to explain each step of a mechanism in economics. This happens, resulting to this, which leads to this, etc are all phrases which make this easy. This isn't evident here, and as a result the display of understanding is poor. The only paragraph which manages this progression is the one starting "Prices fall in a deflating economic environment". The consequences are fully explained, and this becomes a strong point. The conclusion could be much stronger. Yes, it makes a justified judgement, but there needs to be some comment on which factor affects why one is more serious than the other. I would be looking at a simple discussion of the size of inflation or deflation: small deflation is better than hyperinflation. When doing an evaluation like this, I ask myself the question "Will it always happen?" It isn't difficult to pick up evaluative marks if you explore the avenues which will affect this. So, in the context of this question, I will be looking at the justified judgement of deflation being worse and questioning whether it always happens. Then, using phrases such as "it depends upon" and "trends show that" you can make some strong evaluative conclusions.

Response to question

This essay engages well with the costs and benefits of both inflation and deflation, however I feel there isn't enough discussion of which is worse. The command word discuss should signal that some evaluation needs to be included, along the lines of which is more significant, or to what extent is deflation worse than inflation. Yes, this essays concludes by saying deflation is worse, but it could go deeper into saying there may be times when inflation is worse. For example, hyperinflation. I just get the feeling that this is looking at the surface rather than in depth to the question.

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