What Is Deflation And How It Affects You
When a business cycle turns, there are three distinct stages that it moves through. These are known as accumulation, expansion and breakdown. Business cycles generally run through four stages, although there can be instances where two or more of these stages can occur in rapid succession. When you know what stage a particular business cycle is in, it becomes easier to understand what will occur next.
Accumulation occurs when inflation is high and demand exceeds supply. In this stage, prices are driven up because of a higher demand and there are no downward movements in supply. The increased prices are meant to meet the increasing need. With nowhere to sell the increased inventory, there is little chance of profit. When inflation falls, supply catches up and there is a slowing in price increases.
Excess inventory generally occurs when demand exceeds supply and this causes manufacturers to expand capacity. As capacity is expanded, so does the need for more inventory. Manufacturers tend to keep excess inventories tied up until they are needed. This causes a problem in the business cycle as the economy slows down and businesses slow down in their efforts to keep inventories full. If there is deflation, the effect is the same – manufacturers and distributors are forced to keep their inventories at full capacity even if they don’t need to.
When is deflation most likely to occur in the business cycle when is the likelihood that there will be no growth in the economy.
As previously stated deflation causes a reduction in the amount of goods that are produced. When this happens, it becomes difficult for companies to plan and increase production levels. When there are no growth in the economy and the number of companies in business decreases, it becomes difficult for consumers to pay for the increased amount of goods that are produced. The result of this increased in goods costs are higher inflation rates and lower consumer spending.
Another factor in the business cycle when is deflation most likely to occur is a change in the balance of trade. Balance of trade refers to the difference between total sales and purchases. When there is a deficit in the economy, companies that are exporting spend less money with the difference coming out of the companies that are buying from abroad. It is difficult for a country to increase its imports when the other country has a surplus. Inflation causes companies to reduce their purchases so that they have enough money on hand to cover their purchases.
It is difficult to say when is deflation most likely to occur since the business cycle is something that is extremely complex and changes significantly depending on the state of the economy. The most likely time when you would expect to find deflation is during a period where the inflation rate is rising because of a rise in the cost of goods and services. If the cost of goods is increasing, then companies will reduce the amount of items that they are buying to stay profitable. However, when companies are still making profits, deflation often sets in due to a fall in the demand for goods as consumers become more cautious when spending money.
