Is it possible for the price level to fall (deflation) while production and employment both rise? 

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pohnpei397 eNotes educator| Certified Educator

Yes, this is possible.  It happens if there is an increase in aggregate supply while there is less or no change in aggregate demand.  This is why many economists believe that it is better to increase aggregate supply than to increase aggregate demand.

When aggregate supply rises, it is shown on a graph by a movement of the aggregate supply curve to the right.  If the aggregated demand curve does not move, the new equilibrium is at a point where real GDP is higher (more production and more employment) while the Consumer Price Index is lower (deflation).