1. The level of prices and the value of money 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. In year two, the price of the same basket is $9.00. From year one to year two, there is at an annual rate of . In year one, $80.00 will buy baskets, and in year two, $80.00 will buy baskets. This example illustrates that, as the price level falls, the value of money .

Deflation; 10%

8; 9 basket of goods

rises

Explanation:

Given that,

Price of  a basket of goods in year 1 = $10

Price of the same basket in year 2 = $9

There is a fall in the price level from year 1 to year 2, hence, this is known as the deflation in an economy.

Deflation rate:

= [(Price of  a basket of goods in year 1 - Price of the same basket in year 2) ÷ Price of  a basket of goods in year 1] × 100

= [($10 - $9) ÷ $10] × 100

= 10%

In year 1,

$80.00 will buy:

= $80 ÷ Price of  a basket of goods in year 1

= $80 ÷ $10

= 8 baskets of goods

In year 2,

$80.00 will buy:

= $80 ÷ Price of  a basket of goods in year 2

= $80 ÷ $9

= 8.9 or 9 baskets of goods

Therefore, this example indicates that as the price of the goods falls then as a result the value of money rises because with the lower price level, a person can purchase more quantity of goods.

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