Inflation rate determines price level changes

Steps:

• Identify inflation rate for each year from the diagram: positive in years 1-3, negative in year 4.
• Positive inflation rate means the general price level rises year-over-year.
• Zero inflation rate means the general price level stays constant.
• Negative inflation rate (deflation) means the general price level falls.

Why D is correct:

• Inflation is the percentage change in the price level; positive rates for years 1-3 cause rises, while the negative rate in year 4 causes a fall.

Why the others are wrong:

• A: Assumes unwarranted constants in years 1-2 and a fall in year 3, ignoring positive inflation.
• B: Includes too many constants and an extra fall, misreading the diagram's positive rates.
• C: Fails to account for the negative inflation in year 4, which causes a fall.

Final answer: D