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A country facing a balance of payments deficit will change the pegged value of its
currency; this is called a revaluation.
Additional Application INFLATION-INDEXED BONDS IN THE UNITED
STATES
Are there bonds that can protect your investments from inflation? In 1997, the U.S.
Department of the Treasury created a new financial instrument called the Treasury
Inflation-Protected Security, or TIPS. The key feature of TIPS is that the payments to
investors adjust automatically to compensate for the actual changes in the Consumer
Price Index. Therefore, TIPS provide protection to investors from inflation. Like other
government bonds, TIPS make interest payments every six months and a payment of
the original principal when the bond matures. However, unlike other Treasury bonds,
these payments are automatically adjusted for changes in inflation. Despite their
obvious attractions, the market for TIPS is still rather small. As of 2005, there were
about $200 billion in TIPS outstanding, compared to a total volume of about $4 trillion
($4,000 billion) total Treasury obligations. Because TIPS compensate for actual
inflation, the interest rate on these bonds differs from conventional bonds by the
expected inflation rate. By comparing the interest rates on TIPS to other government
bonds of similar maturity, economists can estimate the public's expectations of inflation.
SOURCE: Simon Kwan, "Inflation Expectations: How the Market Speaks," Federal
Reserve Bank of San Francisco Economic Letter, October 7, 2005. Because of the
attractiveness of TIPS over conventional securities, the volume of TIPS transacted in
the market in 2005 was larger than the volume of conventional (non-inflation indexed)
securities.
National policy always overrides free trade in matters of environmental concern.
Recall Application 2, "Increased Political Independence for the Bank of England
Lowered Inflation Expectations," to answer the following questions:
Based on the application, the Bank of England's independence lowered the public's
expectations of inflation.
In an open economy, increases in government spending can crowd out consumption,
investment, or net exports.
The consumption function shows the relationship between consumer spending and price
level.
The Phillips curve suggests that if we want to lower the inflation rate, we must accept a
higher unemployment rate in return.
Complementary goods are goods that are normally consumed together.
Both increases in the price level and increases in real GDP will decrease the demand for
money.
Contractionary policies are government policies that
A) increase aggregate supply.
B) decrease aggregate supply.
C) decrease aggregate demand.
D) increase aggregate demand.
The principle of diminishing returns does not apply to labor when all inputs are allowed
to vary because:
A) a firm can build an additional production facility so each worker's share of the
facility doesn't necessarily decrease.
B) eventually the marginal product of labor will begin to increase again.
C) a firm can fire inefficient workers.
D) None of the above, diminishing returns always apply.
Increasing the required reserve ratio shifts the money supply curve to the ________ and
________ the equilibrium interest rate.
A) left; increases
B) right; increases
C) left; decreases
D) right; decreases
Table 5.3
Refer to Table 5.3. Suppose this economy produces only the two goods X and Y. If year
1 is the base year, the percentage growth rate in Real GDP between year 1 and year 2 is:
A) about 45 percent.
B) about 90 percent.
C) about 30 percent.
D) about 2 percent.
If the tariffs on the textiles, apparel items and footwear mentioned in the Application
were replaced by equivalent voluntary export restraints (VERs), who would benefit the
most?
A) low-income consumers
B) high-income consumers
C) the U.S. government
D) the foreign manufacturer
Many economists believe that each year inflation is overestimated by between:
A) 2.5% and 3.5%.
B) 0.1% and 0.5%.
C) 0.5% and 1.5%.
D) 1.5% and 2.5%.
Suppose that the expected inflation rate is 8 percent and the actual inflation rate is 8
percent. Then borrowers
A) and lenders are both worse off.
B) and lenders are both better off.
C) are better off and lenders are worse off.
D) none of the above
The marginal propensity to consume (MPC) is equal to
A) MPS + 1.
B) MPS - 1.
C) 1 - MPS.
D) 1 + MPS.
Jamie transfers $150 from his money market fund to his checking account. This
transaction will:
A) decrease M2 and increase M1.
B) increase M1, but leave M2 unchanged.
C) decrease M1 and increase M2.
D) decrease both M1 and M2.
A 'shoe-leather cost" is the cost associated with:
A) changing price lists when there is inflation.
B) trying to reduce holdings of cash when there is inflation.
C) designing a new basketball sneakers when there is inflation.
D) buying new shoes when there is inflation.
The marginal principle states that "we should increase the level of an activity as long as:
A) its marginal benefit exceeds it marginal cost."
B) its marginal cost exceeds its marginal benefit."
C) its total benefit exceeds its total cost."
D) its total cost exceeds its total benefit."
Which of the following contributed to the U.S. budget deficit in 2009?
A) the U.S. recession in 2007-2009
B) the large expenses associated with the wars in Iraq and Afghanistan
C) the large stimulus package in 2009.
D) All of the above are correct.
When there is imperfect competition, the role of the government is to:
A) take over production.
B) tell the firms how much to produce.
C) foster competition.
D) all of the above.
The reason why the government taxes the gasoline used by pollution-causing
automobiles is because it is trying to:
A) make the drivers face the full cost of their driving decisions.
B) make the government face the full cost of the driver's driving decisions.
C) make the oil companies face the full cost of the driver's driving decisions.
D) make the people who suffer from asthma face the full cost of the driver's driving
decisions.
In a market economy, what provides potential investors with reliable information about
the financial performance of a firm?
A) contracts
B) insurance
C) patents
D) accounting rules
Suppose that the current price in a market for Pizza is $9. At that price, the quantity
demanded is 519 and the quantity supplied is 400. In this market, we would expect that:
A) the price of pizzas would increase.
B) the price of pizzas would decrease.
C) buyers would want to buy more pizza in the future.
D) sellers would want to sell fewer pizzas in the future.
Traveler's checks are included in
A) M1 only.
B) M2 only.
C) both M1 and M2.
D) neither M1 nor M2.
If the price level increases from 120 to 320 in one month, the economy is experiencing:
A) hyperinflation.
B) inflation.
C) both A and B
D) neither A nor B
The mechanism that normally coordinates what goes on in an economy is the
A) government.
B) price system.
C) stock market.
D) Federal Reserve.
What are supply shocks? Explain what effect adverse and favorable supply shocks have
on the supply curve.
Suppose the economy is initially operating at the potential level of output. Graphically
illustrate and explain what effect a one-time permanent reduction in the money supply
will have on output and the price level in the short run and in the long run.
Suppose policy makers want to increase GDP by $450 billion. If the marginal
propensity to consume is 0.9, by how much must taxes decrease to achieve this target?
Is it possible for the Fed to reduce the inflation rate with little increase in the
unemployment rate? Explain.
What is an export?
What is the difference between the medium of exchange and unit of account functions
of money?
