Question

Suppose the price level reflects the number of dollars needed to buy a basket of goods containing one cup of tea, one biscuit, and one magazine. 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:

Deflation; 12.50%

5; 5.71

Increases

Explanation:

The percentage change in the basket cost is:

$P = \frac{7.00-8.00}{8.00}=-0.125 = -12.50\%$

A negative change in cost means that there was a deflation.

From year one to year two, there is deflation at an annual rate of 12.50%.

The number of baskets that could be bought in years one and two are:

$n_1 = \frac{40}{8} =5\\n_2 = \frac{40}{7}=5.71$

In year one, $40.00 will buy 5 baskets, and in year two, $40.00 will buy 5.71 baskets.

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