(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.