Which of the following best describes the difference between inflation and deflation?

• A. Inflation is caused by a decrease in the money supply, while deflation is caused by an increase in the money supply.
• B. Inflation and deflation both refer to a rise in the value of money over time.
• C. Inflation leads to higher purchasing power, while deflation leads to lower purchasing power.
• D. Inflation is a general increase in the price level of goods and services, while deflation is a general decrease in the price level.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the definitions of inflation and deflation. Inflation refers to a general increase in the price level of goods and services over time, meaning that the average prices rise and the purchasing power of money falls.
2. Step 2: Recognize that deflation is the opposite of inflation. It is a general decrease in the price level of goods and services, which means prices fall and the purchasing power of money increases.
3. Step 3: Analyze the options given by comparing them to these definitions. For example, inflation is not caused by a decrease in the money supply; typically, an increase in the money supply can cause inflation.
4. Step 4: Note that inflation and deflation do not both refer to a rise in the value of money; inflation actually means the value of money decreases, while deflation means it increases.
5. Step 5: Conclude that the best description is the one that correctly states inflation as a general increase in prices and deflation as a general decrease in prices, reflecting their true economic meanings.