If an economy experiences deflation, then which of the following is most likely to occur?

• A. Interest rates rise due to increased demand for loans.
• B. The general price level decreases over time.
• C. The purchasing power of money decreases.
• D. The unemployment rate falls rapidly.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of deflation. Deflation refers to a decrease in the general price level of goods and services in an economy over a period of time.
2. Step 2: Recall the relationship between deflation and purchasing power. When deflation occurs, prices fall, which means each unit of currency can buy more goods and services, so the purchasing power of money actually increases, not decreases.
3. Step 3: Analyze the impact of deflation on interest rates. Typically, deflation leads to lower interest rates because the real value of debt increases, discouraging borrowing rather than increasing demand for loans.
4. Step 4: Consider the effect of deflation on unemployment. Deflation can lead to higher unemployment because falling prices may reduce business revenues and profits, causing firms to cut back on production and labor.
5. Step 5: Conclude that the most accurate statement about deflation is that the general price level decreases over time, which is the defining characteristic of deflation.