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 $9.00. In year two, the price of the same basket is $8.00. From year one to year two, there is at an annual rate of . In year one, $72.00 will buy baskets, and in year two, $72.00 will buy baskets. This example illustrates that, as the price level falls, the value of money . rises,falls,remains the same

Answer 1

Answer:

From Year 1 to Year 2 : There is annual deflation 11.11%

As price falls, value of money rises

Explanation:

Given : Commodity Basket Cost = $9 in Year 1 ; Commodity Basket Cost = $8 in Year 2

From Year 1 to Year 2 : There has been fall in price level. Proportionate (%) Fall in price level = Change in Price / Old Price x 100

So, Fall in price level = [ ( 9 - 8 ) / 9] x 100 = 1/9 x 100 = 11.11%

Hence, from year 1 to year 2 : there has been 11% fall in price i.e Deflation

Considering Income = $72  :

• Year 1 : It can purchase 72 / 9 = 8 commodity baskets
• Year 2 : It can purchase 72 / 8 = 9 commodity baskets

So, it illustrates that : As price falls, the purchasing power of money (value of money) rises.