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 .

Deflation; 12.50%

5; 5.71

Increases

Explanation:

The percentage change in the basket cost is:

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:

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.

b is the correct answer

a. money supply  

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