Definition of 'Deflation'

A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Central banks attempt to stop severe deflation, along with severe inflation, in an attempt to keep the excessive drop in prices to a minimum. The decline in prices of assets, is often known as Asset Deflation. Read more: http://www.investopedia.com/terms/d/deflation.asp#ixzz1o8en5uvW
Shouldn't consumers be happy when prices fall? That depends on what causes deflation. When technological progress leads to rising productivity, or output per hour of work, the economy can produce more each year with the same workers and equipment, and companies can cut prices while increasing sales. Between 1865 and 1879, manufacturing output rose 6% a year while prices fell by 3% a year. Wages were basically unchanged. Deflation is more worrisome when it results from declining demand, as it did during the Great Depression when prices tumbled 24% between 1929 and 1933, bankruptcies mounted, thousands of banks failed and the unemployment rate hit 25%. EFFECTS OF DEFLATION A company borrows on the assumption that rising sales volumes and prices will enable it to repay the debt. As prices fall, it becomes more difficult to make payments on debt. A company may be forced to cut wages or jobs, or go bankrupt. The same applies to households that suffer falling income and have to cut spending to service debts. If too many businesses and households do this, the result is depressed demand that fuels further deflation. Another risk from deflation is that consumers may delay spending because they expect goods and services to get cheaper. The odds of deflation also are damped by the fact that inflation has been low and stable for years. As long as businesses and consumers expect that to continue, and set prices and wages accordingly, the deflation risks are diminished. Deflation is dangerous because it makes it hard to boost the economy by cutting interest rates, and because it makes debt harder to repay.

Deflation is nothing but a fall in the general price level. In order to understand the circumstances under which Deflation occurs and affects an economic condition, one needs to go through the causes of Deflation. Causes of Deflation:

Capitalism characterized by sufficient existence of competition, is regarded as one of the factors responsible for the emergence of Deflation. In this case, with the improvement in the capital stocks, competition increases million fold. Escalation in the total number of competitors boosts up the supply of goods, indicating that the prices must decrease in order to stabilize the demand, thereby bringing in Deflation. Capitalism also brings in innovation and efficiency, which also contributes towards the initiation of Deflation.

 In an economy based on credit, a decrease in money supply results in remarkably less lending trend, followed by a sharp decline in the money supply. As a result, there occurs a sharp reduction in the demand for goods. A decline in the demand is followed by a decline in the prices, owing to the development of a condition called the supply glut. Gradually, this assumes the form of a deflationary spiral, where the prices go down below the costs of financing production. With the advent of deflationary spiral in an economy, the commercial sector of the country stops incurring profits, despite lowering the prices of their finished products. Ultimately, a situation arises where this commercial sector is forced to become liquidated. In order to prevent or slacken down the deflationary spiral, it is necessary for the banks to avoid the collection of non-performing loans. According to the monetarist viewpoint, Deflation occurs when there is a decrease in the velocity of money, and/or in the amount of monetary supply per person. Deflation helps the economy grow and develop at a rapid pace, even faster than the creation of hard money. To sum up, deflation arises due to the following conditions stated below: Decrease in the money supply Inscrease in the supply of goods Fall in the demand for goods Escalation in the demand for money