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 $10.00.1. In year two, the price of the same basket is $9.00. Is this called inflation or deflation? What is the annual rate of it?2. How many baskets can $80.00 buy in year one? How many in year two?3. What happens to the value of money if the price level falls?

Answer 1

Answer:

1. Deflation

-10%

2. In year 1 - 8 baskets

In year 2 - 8.9 baskets

3. The value of money increases

Explanation:

Deflation is a fall in general price levels. The price fell from $10 to $9. It indicates deflation has occured.

Inflation is a rise in price level.

Annual rate = (current year price - previous year price ) / previous year price

(9 - 10) / 10 = -0.1 = -10%

The annual change is negative because price level fell.

$80 would buy $80/$10 = 8 baskets of goods in year 1

$80 Will buy $80/$9 = 8.9 baskets of goods in year 2.

A fall in price levels increases the value of money because less money can buy the same basket of goods. Therefore, the purchasing power of money increases.