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 can of seltzer, one bag of pretzels, and one shuttle ride. In year one, the basket costs $15.00. In year two, the price of the same basket is 14.00. From year one to year two, there is w at an annual rate of v o deflation . . . inflation In year one, $120.00 will buy % baskets, and in year two, $120.00 will buy " bas - This example illustrates that, as the price level falls, the value of money 2. Money supply, money demand, and adjustment to monetary equilibrium The following table gives the quantity of money demanded at various price levels (P), the money demand schedule. In the following table, fill in the column labeled Value of Money. Quantity of Money Demanded Price Level (P) Value of Money (1/P) (Billions of dollars) 0.80 v 1.5 1.00 v 2.0 1.33 v 3.5 2.00 v 7.0 Mow consider the relationship between the quantity of money that people demand and the price level. The lower the price level, the " money required to complete transactions, and the "% money people will want to hold in the form of currency or demand deposits. Assume that the Federal Reserve initially fixes the quantity of money supplied at $3.5 billion. Use the orange line (square symbal) to plot the initial maney supply (MS1) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve. 2.00 1.75 MS 1.50 O 1.25 Money Demand 1.00 VALUE OF MONEY 0.75 MS2 0.50 0.25 ca 1 2 3 4 5 6 7 QUANTITY OF MONEY (Billions of dollars)According to your graph, the equilibrium value of money is % |, therefore the equilibrium price level is Mow, suppose that the Fed increases the money supply from the initial level of $3.5 billion to 57 billion. In order to increase the money supply, the Fed can use open market operations to w the public. Use the purple line (diamond symbol) to plot the new money supply (MSa). Immediately after the Fed changes the money supply from its initial equilibrium level, the gquantity of meney supplied is W than the quantity of money demanded at the initial equilibrium. This expansion in the money supply will W people's demand for goods and services. In the long run, since the economy's ability to produce goods and services has not changed, the prices of goods and services will " and the value of money will w