Causes of Falling Prices
What are the causes of falling prices? Let’s go over them here! There is a glut of reasons for falling prices in the economy. We will go over what causes falling prices in the short run and long run.
Causes of Falling Prices in The Short Run
In the short run, falling prices will usually be caused by fluctuations in the business cycle. The business cycle is a series of expansions and contractions in the economy. When the economy is contracting, deflation will tend to occur, and as a result, falling prices will be present. In contrast, when the economy is expanding, inflation will tend to occur, and as a result, rising prices will be present.
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Causes of Falling Prices in The Long Run
In the long run, falling prices will usually be caused by the money supply in the economy. The institution that typically controls the money supply is the central bank. In the United States, this is the Federal Reserve. If the Federal Reserve implements a contractionary monetary policy, then the money supply in the economy will decrease, which leads to a decrease in demand, which will lead to a decrease in the overall price level. In contrast, if the Federal Reserve implements an expansionary monetary policy, then the money supply will increase, which leads to an increase in demand, which will lead to an increase in the overall price level.
Causes of Falling Prices: Misconception
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A common misconception regarding the cause of falling prices revolves around supply and demand. Many believe that falling prices are merely a result of supply and demand issues. While this is true for certain goods relative to others, this will seldom be true for the price of all goods and services in the economy.
Price Falling Examples
Let’s go over an example of a price falling. To do so, we will look at falling prices in the short run and the long run.
Price Falling Example in the Short Run
In the short run, falling prices will occur due to fluctuations in the business cycle.
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Fig. 1 – Business Cycle
What is shown in the graph above? Above is a graph of a business cycle. Anytime the curve is downward sloping, there is a contraction in the economy. At those points, there will be falling prices in the economy due to decreased demand. In contrast, anytime the curve is upward-sloping, there is an expansion in the economy. At those points, there will be rising prices in the economy due to increased demand.
Price Falling Example in the Long Run
In the long run, falling prices will occur due to the money supply. In the United States, the Federal Reserve is primarily in charge of the money supply. Therefore, it has a big influence on whether prices fall or rise in the economy.
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