Question

Suppose the price level reflects the number of dollars needed to buy a basket of goods containing one can of soda, one bag of chips, and one comic book. In year one, the basket costs $8.00. In year two, the price of the same basket is $7.00. From year one to year two, there is at an annual rate of . In year one, $40.00 will buy baskets, and in year two, $40.00 will buy baskets. This example illustrates that, as the price level falls, the value of money .

Answer 1

Answer: The answer is as follows:

Step-by-step explanation:

Price of basket in year one = $8

Price of basket in year two = $7

So, from year one to year two there is a fall in the price level which means that there is deflation in the economy at an annual rate of :

`(P_(2) -P _(1))/(P_(1) ) * 100`

=
`(7 - 8)/(8) * 100`

= -12.50%

In year one, $40 will buy
`(40)/(8)` = 5 Baskets

In year two, $40 will buy
`(40)/(7)` = 5.71 Baskets

Value of money =
`(1)/(price\ level)`

Hence, this example illustrates that, as the price level falls, the value of money increases.