Question

Inflation and deflation describe long-term trends in prices. Inflation means that the same thing will cost more in the future, while deflation means they cost less. When a business decision span several years these concepts need to be address. How would you account for them in your business decision analysis?

Answer 1

Inflation occurs when the prices of goods and services rise,while deflation occurs when those prices decrease.The balance between these two economic conditions,opposite sides of the same coin,is delicate and an economy can quickly swing from one condition to other.Central banks keep a keen eye on the levels of price changes and act to stem deflation or inflation by conducting monetray policy measures such as interest rates.

Inflation is a quantative measure of how quickly the price of an economy is increasing.Inflation is caused when goods and services are in high demand,thus creating a drop in availability.The most common measure of inflation is the Consumer Price Index(CPI).Hyper inflation occurs when the increase in monthly prices exceeds 50% over some period of time.These periods of rapid increases are often accompanied by a breakdown in the underlying real economy and may also see a sudden increase in the money supplty.

Deflation occurs when too many goods are available or when there is not enough money circulating to pruchase those goods.As a result, the price of goods and services drops.Deflation can lead to an economic recession or depression and the central banks usually work to stop deflation as soon as it starts.

The effects of inflation are wide ranging,including not only individuals but also businesses and even countries.Consumers and businesses alike have to deal with the impact of inflation.If costs are rising due to inflation a business may not be able to pass them on to customers.Inflation can disrupt business planning and lead to lower investments.It is also associated with higher investments and reduces economic growth which leads to recession.The effects can reinforce the price of bills,travel and commodities.Even the smallest of changes has a knock-on effects for every homeowner,commuter and consumer.Small business should be attentive,accute and responsive to changes in inflation.Rising cost for businesses could result in bigger production spends and falling profitability.

Deflation is usually associated with significant unemployment,which is only corrected after wages drop considerably.Furthermore,businesses' profits drop significantly during periods of deflation,making it more difficult to raise additional capital to expand and develop new technologies.If deflation is exacerbated,it can throw an economy into a deflationary spiral.This happens when price decreases lead to lower production level which inturn leads to lower wages,which leads to lower demad by businesses and consumers,which lead to further decrease in prices.