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 it 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 _____.