Subjective Short Answer
1. The increase in the overall level of prices is known as _____.
2. If the price level this year was 140 and was 135 last year, what was the inflation rate to the nearest decimal?
3. The consumer price index increases from 200 to 208. What is the inflation rate?
4. A decrease in the overall price level (or falling prices) is called _____. An extraordinarily high rate of inflation is called
_____.
5. The theory that most economists rely on to explain inflation is called the __________.
6. An increase in the price level means that a dollar buys __________ goods and services so the value of a dollar
__________.
7. It takes more money to purchase the same amount of goods when prices _____. Therefore, the value of your money has
____.
8. An increase in the price level causes the value of money to _____. Therefore, people will want to hold ____ money,
because the cost of their purchases has increased.
9. When the consumer price index increases, the value of your money has _____. According to the quantity theory of
money this is caused by an increase in the _____.
10. If the price level were to rise from 160 to 200, in what direction and by how much would the value of a dollar change?
11. A decrease in the value of money __________ the quantity of money demanded. On a graph with the value of money
on the vertical axis this effect on the value of money on quantity demanded is shown as ____________.
12. In the long run an increase in the money supply causes the price level to __________. The price level moves in this
direction because an increase in the money supply creates __________ in the money market that causes people to
________ spending.
13. According to the quantity theory of money, an increase in the money supply causes the price level to _____ and the
value of money to _____.
14. When the Federal Reserve injects money into the banking system, it initially causes an excess _____ of money.
Equilibrium in the money market is reestablished through a(n) _____ in the price level.
15. The classical dichotomy says that two groups of variables are affected by different forces. What are these two groups
of variables?
16. You hear an economist state the following: “The increase in the money supply will causes price to rise in the long run
and will have no effect on output or any other real factors.” This economist is expressing the principle of _____.
17. Money neutrality states that a change in the money supply affects _____ variables only. Most economists believe that
money neutrality is a good description of how money affects the economy in the _____.
18. An economy produces two goods, x and y. A year ago the price of x was $4 and the price of y was $6. Today the price
of x is $8 and the price of y is $10. What happened to the nominal and the real value of good x? What happened to the
nominal and real value of good y?
19. The quantity equation is expressed as _____. The rate at which money changes hands is known as _____.
20. If velocity is 6, real output is 10,000, and M is 20,000 what would the price level be? If M increases to 25,000 but V
and Y do not change, what happens to the price level? Are the change in the money supply and the change in the price
level proportional?
21. According to the classical dichotomy and money neutrality, a doubling of the money supply, holding all else constant,
causes prices to _____ and real GDP to _____.
22. What two key assumptions does the quantity theory make concerning variables in the equation of exchange?
23. What direction of change in velocity could explain the price level increasing by a smaller percentage than the money
supply? What would this change in velocity imply about the frequency with which money changes hands?
24. In the long run inflation is explained by __________. For countries that had hyperinflation this source of inflation
arose primarily because the government __________.
25. If the government were to run a budget deficit and wanted to finance it by printing money, would it have the central
bank conduct open market purchases or open market sales?
26. The _____ interest rate tells you how fast the number of dollars in your bank account will rise over time, and it is the
sum of the _____ interest rate and the _____.
27. According to the Fisher effect, if the central bank raises the rate of money supply growth, what happens to the nominal
and the real interest rate?
28. The nominal interest rate is eight percent and the consumer price index rises from 140 to 147. What is the real interest
rate?
29. Suppose the rate of inflation rate is two percent and the nominal interest rate is five percent. According to the Fisher
Effect, an increase in the inflation rate to six percent should cause the nominal interest rate to increase from five percent to
_____ in the long run.
30. Jackie saves $100 and receives $106 the next year. During the same year, the price of the basket of goods that she
purchases increases from $100 to $104. What is nominal interest rate on Jackie’s saving? What is the real interest rate on
Jackie’s saving? What was the inflation rate?
31. Some countries have experienced an extraordinarily high rate of inflation known as _____. This is usually due to
governments using money creation as a way to pay for their spending. The revenue the government raises by creating
money is called the _____.
32. The inflation tax alters people’s behavior and creates a deadweight loss. Explain.
33. Does an increase in the inflation rate increase or decrease the amount of money people choose to hold at any given
price level? What would an increase in the inflation rate do to money demand? What would this change in money demand
do to the price level?
34. Your grandfather tells you that his annual income increased at an average rate of eight percent over his lifetime. He
complains, however, that the average inflation rate of three percent reduced his ability to buy all the things he could have
purchased if inflation had been zero. You respectfully tell your grandfather that he is committing the _____, because his
annual income would have increased at an average rate of only five percent if inflation had been zero.
35. During hyperinflations, people desire to hold less money and will go to the bank more frequently. This waste of
resources due to the high rate of inflation is known as _____.
36. In the early 1920s U.S. consumer prices fell, while Germany experienced hyperinflation. According to the ideas of
shoeleather costs and menu costs, U.S. households (relative to German households) made _____ frequent trips to the bank
and U.S. firms changed prices _____ frequently.
37. The costs a business incurs to change its prices are called ___________.
38. The idea that firms incur actual costs when they change prices is known as _____. Firms in countries with lower
inflation rates will change price _____ frequently compared to those countries where inflation is higher.
39. What are menu costs and why does high inflation increase menu costs?
40. Given that firms change their prices infrequently, a business that has just raised its price will have a __________
relative price; over time as its price remains fixed its relative price __________.
41. One benefit of low inflation is that it _____ the variability of relative price changes. Therefore, resources are _____
likely to be better allocated.
42. In the U.S., taxes are paid on one’s _____ gains/returns. Therefore, a _____ inflation rate encourages more saving.
43. Fifteen years ago your parents purchased some land with the idea of selling it later to help pay your college expenses.
They purchased the land for $100,000. They sold if for $180,000. During the time they held it the price level rose from 80
to 120. If your parents face a 25% tax rate, what was their real after-tax gain? (Hint: What’s the real value of the land in
current prices?)
44. One year ago Sam purchased bonds for $100,000. He just sold them for $120,000. During the year the price level rose
by 5%. If the tax rate on capital gains is 20%, how much did Sam gain in real terms?
45. If the inflation rate was 10%, and the tax rate was 25%, and you deposited money in a bank account that paid 14%,
what is after tax real interest rate? Show you work.
46. If the inflation rate was 8%, and the tax rate was 20%, and you deposited money in a bank account that pays 12%,
what is your after tax real interest rate? Show you work.
47. You earn a nominal return of 6% on your savings and the tax rate is 20%. If the rate of inflation is 2%, what are the
before-tax real interest rate and your after-tax rate of return?
48. If inflation is less than expected, who is wealth redistributed to?
49. Mitch makes payments on a car loan. If the price level a year ago was 120 and people expected it to rise to 125 but it
actually rose to 128, what happened to the real value of Mitch’s payment as opposed to what he was expecting to happen?
Express your answer to the nearest 100th.
50. During the late 19th century, the U.S. price level fell. This unexpected increase in the real cost of borrowing caused
wealth to be redistributed from _____ to _____.
51. Why did farmers in the late 1800s dislike deflation?
52. Explain the adjustment process in the money market that creates a change in the price level when the money supply
increases.
53. Suppose the Fed sells government bonds. Use a graph of the money market to show what this does to the value of
money.
worth more, it takes less to buy goods with it, which means the price level falls.
54. Using separate graphs, demonstrate what happens to the money supply, money demand, the value of money, and the
price level if:
a.
b.
money to fall, so the price level rises.
money and so a higher price level.
55. According to the classical dichotomy, what changes nominal variables? What changes real variables?
productivity and real changes in the factor and loanable funds markets.
56. Suppose that monetary neutrality holds. Of the following variables, which ones do not change when the money supply
increases?
a.
b.
c.
d.
e.
f.
a.
real interest rates
d.
real output
e.
real wages
57. Wages and prices are many times higher today than they were 30 years ago, yet people do not work a lot more hours
or buy fewer goods. How can this be?
response to changes in real variables, not nominal ones.
58. Identify each of the following as nominal or real variables.
a.
b.
c.
d.
e.
f.
g.
h.
a.
real variable
b.
nominal variable
c.
nominal variable
d.
real variable
e.
real variable
f.
nominal variable
g.
real variable
h.
nominal variable
59. Define each of the symbols and explain the meaning of M V = P Y.
60. What assumptions are necessary to argue that the quantity equation implies that increases in the money supply lead to
proportional changes in the price level?
no effect on real output.
61. What is the inflation tax, and how might it explain the creation of inflation by a central bank?
The inflation tax refers to the fact that inflation is a tax on money. When prices rise, the
62. Economists agree that increases in the money-supply growth rate increase inflation and that inflation is undesirable.
So why have there been hyperinflations and how have they been ended?
63. Suppose that velocity and output are constant and that the quantity theory and the Fisher effect both hold. What
happens to inflation, real interest rates, and nominal interest rates when the money supply growth rate increases from 5
percent to 10 percent?
64. In recent years Venezuela and Ukraine have had much higher nominal interest rates than the United States while Japan
has had lower nominal interest rates. What would you predict is true about money growth in these other countries? Why?
65. List and define any two of the costs of high inflation.
66. Inflation distorts relative prices. What does this mean and why does it impose a cost on society?
67. Explain how inflation affects savings.