An article in BusinessWeek warned of the dangers of deflation as the collapse of

Question

An article in BusinessWeek warned of the dangers of deflation as the collapse of numerous Asian economies was creating worries that Asia might try to "export its way out of trouble" by oversupplying everything from automobiles to semiconductors. Evidence that deflation had become a genuine concern for managers was provided by a statement in the article by John Smith, chairman and CEO of General Motors Corporation: "Fundamentally, something has changed in the economy. In today's age, you cannot get price increases." The article offers the following advice to managers: "Productivity growth lets companies boost profits even as prices fall." Using short-run production and cost theory, comment on this advice.

Explanation / Answer

By increasing the productivity, the total product increases, which increases the total revenue generated per resources employed. Thus increasing the MRP (Marginal revenue product) of the resources employed. An increase in the MRP allows the firm to employ more resources at a lower cost. Thus this will increase the output and lowers the price , making the firm competitive.

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