(a) What is deflation? (b) Outline any three positive effects of deflation. (c) Explain the ways by which inflation affects any three functions of money.
Explanation
(a) Deflation is a period of persistent fall in the general level of prices of goods and services. (i) Money lenders/ creditors gain because money paid back has higher value. (ii) Improvement in balance of payments due to increase in exports. (iii) Fixed income earners/creditors gain because money buys more baskets of goods. (iv) Increase in the value of money as a result of falling prices. (v) Savings are encouraged because cost of living is low. (vi) Standard of living will increase as a result of reduction in the cost of living. (c)(i) Medium of exchange - during inflation people are likely to lose confidence in money as means of payment for goods and services because of a fall in its value. (ii) Store of value - the function of money as a store of wealth is undermined during periods of inflation because the money saved loses value. (iii) Standard of deferred payment - during inflation money does not serve as an adequate standard of deferred payment because money loses value. (iv) Unit of account/measure of value - during inflation, money is not a reliable unit of account because its own value is not stable.