Unanticipated or Unexpected Price Level Changes

Unanticipated or Unexpected Price Level Changes

Charles Peterson

Grantham University

How will (a) an unexpected 3 percent fall in the price level in the goods and services market differ from (b) 1 percent inflation when 4 percent inflation had been expected? What impact would (a) and (b) have on the real price of resources, profit margins, output, and employment. Explain.

Impact of 3% fall in prices on an Economy

What really happens during deflationary shocks? People increase their savings and spend less, especially if they are in fear of losing their jobs or other sources of income. The stock market experiences turbulent fluctuations and indicates a declining trend while at the same time there is a decrease in company buyouts, mergers and hostile takeovers. Governments revise or effect increasingly strict regulation legislations and implement governmental structural changes. As a result of this behavior, investment strategies will switch to less risky and more conservative investment vehicles. In addition, investment strategies will favor tangible investments (real estate, gold/precious metals, and collectibles) or short-term investments that tend to maintain their values and provide the consumer with more stable purchasing power.

If deflation is exacerbated, it can throw an economy into a deflationary spiral. This happens when price decreases lead to lower production levels, which, in turn, leads to lower wages, which leads to lower demand by businesses and consumers, which lead to further decreases in prices. Two sectors of the economy that have traditionally remained well-insulated from economic downturns are education and healthcare as their costs and prices may actually increase while the general level of prices for most goods and services declines.

Deflation is generally considered to have a negative impact on stocks, since lower prices over a long timeframe tend to hurt bottom-line corporate net income. Moreover, deflation can encourage...