Which of the following is a likely effect of deflation?

• A. A decrease in consumer spending due to expectations of lower future prices
• B. A rise in nominal wages across the economy
• C. An increase in aggregate demand as prices fall
• D. A reduction in the real value of debt for borrowers

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of deflation. Deflation is a decrease in the general price level of goods and services in an economy over a period of time.
2. Step 2: Analyze how deflation affects consumer behavior. When prices are falling, consumers may delay purchases expecting prices to drop further, which leads to a decrease in consumer spending.
3. Step 3: Consider the impact of deflation on wages. Nominal wages tend to be sticky downward, so a rise in nominal wages during deflation is unlikely; wages often remain the same or fall slowly.
4. Step 4: Evaluate aggregate demand changes. Deflation usually causes aggregate demand to decrease because lower prices reduce spending incentives, contrary to the idea that demand increases as prices fall.
5. Step 5: Examine the effect on debt. Deflation increases the real value of debt, making it harder for borrowers to repay, so a reduction in the real value of debt is not a likely effect.