Value of Money and the Price Level

The value of money means its purchasing power — the quantity of goods and services that one unit of money can buy. If ₹100 buys a certain basket of goods today and only half that basket a few years later, the value of money has fallen to half.

The value of money is measured with reference to the general price level, and the two move in opposite directions. This inverse relationship is the single most important idea in this section:

• When the general price level rises, each rupee buys fewer goods, so the value (purchasing power) of money falls. This is exactly what happens during inflation.
• When the general price level falls, each rupee buys more goods, so the value of money rises. This happens during deflation.

Because it is impractical to track every individual price, the price level is measured through index numbers such as the Wholesale Price Index (WPI) or the Consumer Price Index (CPI). An index compares prices of a representative basket of goods against a chosen base year (taken as 100). …