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26 June, 13:09

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?

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  1. 26 June, 13:20
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    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.
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