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 $10.00.
In year two, the price of the same basket is $9.00. From year one to year two, there is (deflation or inflation) at an annual rate of .
In year one, $50.00 will buy baskets, and in year two, $50.00 will buy baskets.
This example illustrates that, as the price level falls, the value of money (rises, falls or remains the same) .

Deflation

-10%

5

5.6

Rises

Explanation:

Deflation is the reduction in general price levels.

Price levels fell from $10 to $9, thus , deflation has occurred.

Inflation is a persistent rise in general price levels.

Annual rate of change in price level = ($9 / $10) - 1 = -0.01 = -10%

In year 1, $50, will buy $50 / 10 = 5 basket of goods.

In year 2, $50, will buy $50 / $9 = 5.56 basket of goods

As price level falls, the same amount of money can buy more basket of goods. Therefore, the value of money rises as price level falls.

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