Suppose the price level reflects the number of dollars needed to buy a basket of

Question

Suppose the price level reflects the number of dollars needed to buy a basket of goods containing one cup of coffee, one donut, and one newspaper. In year one, the basket costs $9.00. In year two, the price of the same basket is $8.00. From year one to year two, there is (deflation/inflation (1)) at an annual rate of (???? (2)). In year one, $72.00 will buy (?????(3)) baskets, and in year two, $72.00 will buy (?????(4)) baskets. This example illustrates that, as the price level falls, the value of money (rises/falls/remains the same (5)).

Answer questions:

1.

2.

3.

4.

5.

Explanation / Answer

In year two, the price of the same basket is $8.00. From year one to year two, there is deflation at an annual rate of 11.1%. In year one, $72.00 will buy 8 baskets, and in year two, $72.00 will buy 9 baskets. This example illustrates that, as the price level falls, the value of money rises.

1) When there is fall in price level it is known as deflation.

2) The fall rate would be =(9-8)/9=11.1%

3) $72 will buy 8 basket with $9/each

4) $72 will buy 9 baskets with $8/each basket

5) The valeu of money increases as price level falls. Lower inflation means higher money power and vice-versa.

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