What this lesson teaches
I can explain the causes of weak growth, unemployment, and inflation or deflation.
Syllabus 8843, 3.2.2(a). Macroeconomic Issues: Macroeconomic issues and their causes; Undesirable economic growth - persistently low or negative, unsustainable, non-inclusive due to factors such as changes in AD or AS, environmental degradation, inequitable income distribution; Unemployment - demand-deficient, structural, frictional due to factors such as lack of AD, technological changes, mismatch of skills, transition between jobs; Price instability - demand-pull inflation, cost-push inflation, deflation due to factors such as changes in AD, costs of production, productive capacity
I can explain how weak growth, unemployment and unstable prices hurt households, firms and governments.
Syllabus 8843, 3.2.2(b). Macroeconomic Issues: Consequences of undesirable economic growth, unemployment and price instability on the standard of living and its implications for economic agents
Make a guess
Prices across an economy fall for two years. Must consumers be better off?
- Yes. Lower prices mean each dollar buys more, so people are richer.
- No. Falling prices harm consumers, because goods lose quality.
- Not if falling demand is cutting jobs and pay.
Show the answer
Not if falling demand is cutting jobs and pay.
Deflation from weak demand comes with layoffs and lower incomes. It is only benign when it comes from rising productivity.
Deflation from weak demand is harmful; deflation from rising productivity can be benign.
Deflation is a sustained fall in the general price level. Its effects depend on the cause.
Demand-led (malign) deflation: AD falls, so output, jobs and prices fall together. Consumers may delay buying in the hope of lower prices, which cuts AD further in a downward spiral. The real burden of debt also rises.
Supply-led (benign) deflation: productivity rises and costs fall, so AS shifts right. Prices fall while output and jobs rise.
Singapore saw brief periods of falling prices in 2015-16 and 2020, largely because of lower global oil prices and weak demand.
- Malign
- Falling AD: prices, output and jobs fall.
- Benign
- Rising productivity: prices fall, output rises.
Worked example: Falling prices, two causes
In economy A, prices fall while sales and jobs decline. In economy B, productivity rises, costs fall, and firms sell more at lower prices.
- A: AD has fallen: harmful, demand-led deflation.
- B: AS has shifted right: benign, supply-led deflation.
- Both have falling prices, but households in B are better off, and households in A are worse off.
- Look at output and jobs to tell them apart.
Watch out for this
Falling prices are always good for consumers.
Deflation from falling AD comes with job losses and lower incomes, which can outweigh cheaper prices.
Check your understanding
Why can deflation caused by falling AD become a downward spiral?
- Falling prices make exports less competitive, so foreign buyers cut their orders.
- People delay spending as they expect lower prices, cutting AD further.
- Firms raise output when prices fall, so a glut of goods pushes prices lower.
Show the answer
People delay spending as they expect lower prices, cutting AD further.
Right. Lower spending leads to lower output, jobs and prices.