Final answer:
The purchasing power of money is inversely related to the price level due to the wealth effect. This relationship is illustrated by the negatively sloped aggregate demand curve and the practice of indexing wage contracts to maintain purchasing power.
Step-by-step explanation:
The purchasing power of money is inversely related to the price level. This is because as prices increase, each unit of currency buys fewer goods and services; thus, your money's purchasing power goes down. This relationship reflects the wealth effect, which demonstrates that when the price level rises, real wealth is diminished, and consumption spending tends to decrease. This is one of the reasons behind the negative slope of the aggregate demand (AD) curve. Also, indexing wage contracts to the price level aims to preserve the purchasing power and, thereby, the standard of living. An indexed wage contract means that as prices rise, wages correspondingly increase to maintain what your wages can buy.