What this lesson teaches
I can explain the causes of weak growth, unemployment, inflation or deflation and a large trade imbalance.
Syllabus 9570, 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; Persistently large balance of trade deficit or surplus due to factors such as changes in global conditions, international competitiveness, exchange rates
Make a guess
Inflation falls from 6% to 2%. Are prices now lower than last year?
- Yes, by 4%, the drop in the rate.
- No. They are still rising, just more slowly.
- No. Prices are 2% lower, because inflation is now 2%.
Show the answer
No. They are still rising, just more slowly.
A fall in the inflation rate is disinflation. Prices only fall when the rate is negative, which is deflation.
Inflation is rising prices, disinflation is prices rising more slowly, and deflation is falling prices.
Inflation is a sustained rise in the general price level. It is measured by the percentage change in a price index such as the CPI.
Disinflation is a fall in the inflation rate: prices are still rising, but more slowly.
Deflation is a sustained fall in the general price level: a negative inflation rate.
A rise in the price of one good is not inflation. Inflation means prices across the economy are rising.
- Inflation
- Sustained rise in the price level.
- Disinflation
- Inflation rate falls; prices still rise.
- Deflation
- Sustained fall in the price level.
| Year | Path A index | A inflation | Path B index | B inflation |
|---|---|---|---|---|
| 0 | 100 | - | 100 | - |
| 1 | 104 | 4% | 98 | -2% |
| 2 | 106.08 | 2% | 96.04 | -2% |
Worked example: Two price paths
Path A: the price index goes 100, 104, 106.08 (inflation 4% then 2%). Path B: 100, 98, 96.04 (inflation -2% then -2%).
- Path A shows disinflation: prices keep rising, but more slowly.
- Path B shows deflation: prices fall in both years.
- In path A, lower inflation does not bring prices back down; they are still 6% above where they started.
Watch out for this
When inflation falls, prices return to where they were.
Lower inflation means prices are rising more slowly. They only fall with deflation.
Check your understanding
The inflation rate falls from 5% to 1%. What is this?
- A fall in the price level.
- Deflation.
- Disinflation.
Show the answer
Disinflation.
Right. Prices are still rising, just more slowly.