7) Suppose you borrow $1,000 at an interest rate of 12 percent. If the expected real interest rate is 5
percent, then the rate of inflation over the upcoming year that would be most beneficial to you would
be a rate of inflation
A) equal to 0 percent.
B) greater than 7 percent.
C) equal to 7 percent.
D) less than 7 percent.
8) Suppose you lend $1,000 at an interest rate of 10 percent over the next year. If the expected real
interest rate at the beginning of the loan contract is 4 percent, then what rate of inflation over the
upcoming year would be most beneficial to you as the lender? An inflation rate
A) equal to 0 percent.
B) greater than 6 percent.
C) equal to 6 percent.
D) equal to 4 percent.
9) You lend $5,000 to a friend for one year at a nominal interest rate of 10%. Inflation during that year is
5%. As a result, you will receive ________ at the end of the year, but that money has a purchasing power
of ________.
A) $5,050; $5,025
B) $5,100; $5,050
C) $5,500; $5,250
D) $6,000; $5,500
10) When deflation occurs,
A) the real interest rate is greater than the nominal interest rate.
B) the nominal interest rate is greater than the real interest rate.
C) the nominal interest rate is equal to the real interest rate and inflation is negative.
D) the nominal interest rate is equal to the real interest rate and inflation is positive.
11) When prices are rising, which of the following will be true?
A) The real interest rate will be lower than the nominal interest rate.
B) The real interest rate will be negative.
C) The real interest rate will be higher than the nominal interest rate.
D) The nominal interest rate will be negative.
12) During a deflationary period,
A) the nominal interest rate is less than the real interest rate.
B) the real interest rate is less than the nominal interest rate.
C) the price level rises.
D) the nominal interest rate does not change.
13) The real rate of interest is
A) the nominal interest rate plus the inflation rate.
B) the nominal interest rate minus the inflation rate.
C) the interest rate determined by the supply and demand in the money market.
D) the nominal interest rate.
14) If the nominal interest rate is 6% and the inflation rate is 9%, then the real interest rate is
A) -3%.
B) 3%.
C) 6.67%.
D) 15%.
15) If you want to earn a real interest rate of 3% on money you lend, and you expect that inflation will
be 2%, what nominal rate of interest will you charge?
A) 1%
B) 5%
C) 6%
D) 9%
16) If the nominal interest rate is 6% and the inflation rate is 2% then the real interest rate is
A) 8%.
B) 4%.
C) 3%.
D) 2%.
E) 1%.
17) Deflation occurs when
A) there is a sustained increase in the price level.
B) there is a one-time increase in the price level.
C) there is a decline in the price level.
D) there is a decrease in the expected rate of inflation.
18) You lend $5,000 to a friend for one year at a nominal interest rate of 10%. The CPI over that year
rises from 180 to 190. What is the real rate of interest you will earn?
A) 0%
B) 4.4%
C) 5.5%
D) 5.8%
19) You borrow $10,000 from a bank for one year at a nominal interest rate of 5%. If inflation over the
year is 2%, what is the real interest rate you are paying?
A) 2%
B) 2.5%
C) 3%
D) 5%
20) You borrow $10,000 from a bank for one year at a nominal interest rate of 5%. The CPI over that year
rises from 180 to 200. What is the real interest rate you are paying?
A) 15%
B) 5%
C) -1.1%
D) -6.1%
21) The nominal interest rate will be less than the real interest rate when
A) the rate of inflation is positive but decreasing.
B) the rate of inflation is positive and increasing.
C) the rate of inflation is negative.
D) the real interest rate is negative.
22) You agree to lend $1,000 for one year at a nominal interest rate of 10%. You anticipate that inflation
will be 4% over that year. If inflation is instead 3% over that year, which of the following is true?
A) The real interest rate you earn on your money is lower than you expected.
B) The purchasing power of the money that will be repaid to you will be lower than you expected.
C) The person who borrowed the $1,000 will be worse off as a result of the unanticipated decrease in
inflation.
D) The real interest rate you earn on your money will be negative.
23) The nominal interest rate plus the inflation rate equals the real interest rate.
24) If inflationary expectations are increasing, we would expect that the nominal interest rate would
also be increasing, holding all else constant.
25) The nominal interest rate minus the inflation rate equals the real interest rate.
26) If inflation is higher than expected, this helps borrowers (by reducing the real interest rate they pay)
and hurts lenders (by reducing the real interest rate they receive).
27) Real interest rates at times have been negative. Why would anyone lending money agree to a
negative real interest rate?
28) During the 1990s, Japan experienced periods of deflation and very low nominal interest rates,
approaching zero percent. Why would lenders of money agree to a nominal interest rate of almost
zero?
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29) What is the difference between the nominal interest rate and the real interest rate?
30) Suppose you obtain a fixed rate mortgage during a period of relatively high inflation. During the
next ten years, inflation falls. Are you a winner or a loser due to inflation? Explain why.
9.7 Does Inflation Impose Costs on the Economy?
1) Suppose that in 2016, all prices in the economy double and that all wages and salaries also double. In
2016 you
A) are worse off than you were in 2015 as you can no longer afford to buy as many goods and services.
B) are better off than you were in 2015 as your salary is higher than it was in 2015 and you can now buy
more goods and services.
C) are no better off or worse off than you were in 2015 as the purchasing power of your salary has
remained the same.
D) cannot determine whether you are better off or worse off than you were in 2015, because the
purchasing power of your salary cannot be determined.
2) Which of the following describes a situation in which the person is hurt by inflation?
A) a retiree whose pension is adjusted for inflation
B) a person who borrows money during a period when inflation is under-predicted
C) a person who lends money during a period when inflation is over-predicted
D) a person paid a fixed income during an inflationary period
3) If inflation is positive and is perfectly anticipated,
A) those that borrow money lose.
B) those that lend money lose.
C) those that hold paper money lose.
D) no one in the economy loses.
4) Suppose that at the beginning of a loan contract, the real interest rate is 4% and expected inflation is
currently 6%. If actual inflation turns out to be 7% over the loan contract period, then
A) borrowers gain 1% of the loan value.
B) lenders gain 1% of the loan value.
C) borrowers lose 3% of the loan value.
D) lenders gain 3% of the loan value.
5) The cost to firms of changing prices
A) is small even when there is rapid inflation.
B) is called a menu cost.
C) does not exist if inflation is perfectly anticipated.
D) all of the above
6) When actual inflation is less than expected inflation,
A) borrowers lose and lenders gain.
B) borrowers gain and lenders lose.
C) borrowers and lenders both gain.
D) borrowers and lenders both lose.
7) Which of the following is not an example of inflation causing a redistribution of income because the
inflation was unanticipated?
A) A firm signs a 3-year contract with a union based on a 2 percent anticipated rate of inflation per year,
and the actual rate of inflation ends up being 7 percent per year.
B) A worker receives a raise in salary that is less than the rate of inflation, because management under-
predicted inflation.
C) Firms have to hire an extra worker to change prices in its store because of inflation.
D) A bank collects a lower amount of interest from a loan because inflation was under-predicted.
8) If an economy experiences deflation, the real interest rate
A) will be less than the nominal interest rate.
B) will be negative when the nominal interest rate is positive.
C) will be greater than the nominal interest rate.
D) will be equal to the deflation rate, so long as the nominal interest rate is positive.
9) Which of the following individuals would be most negatively affected by anticipated inflation?
A) a retired railroad engineer who receives a fixed income payment every month
B) a union contractor whose pay is adjusted based on changes in the CPI
C) a full-time employee at a pizza parlor who makes more than the minimum wage
D) a student who borrows $10,000 at a nominal interest rate of 5% to finance educational expenses
10) If inflation is completely anticipated,
A) no one loses in the economy.
B) borrowers lose in the economy.
C) lenders lose in the economy.
D) firms lose because they incur menu costs.
11) If inflation increases unexpectedly, then
A) borrowers pay a higher real interest rate than they expected.
B) lenders receive a lower real interest rate than they expected.
C) lenders gain and borrowers gain.
D) neither borrowers nor lenders lose.
12) Which of the following do not suffer the costs of inflation?
A) persons on fixed incomes
B) persons whose incomes rise more rapidly than inflation
C) firms that have to devote more time and labor to raising prices
D) an investor that has to pay higher taxes because of the inflation
13) Inflation that is ________ than what is expected benefits ________ and hurts ________.
A) less; lenders; borrowers
B) less; borrowers; lenders
C) greater; lenders; borrowers
D) greater; lenders; no one
14) The costs to firms of changing prices are called
A) redistribution costs.
B) menu costs.
C) anticipation costs.
D) money illusion costs.
15) What are menu costs?
A) the full list of a firm’s costs of production
B) the costs to a firm of changing prices
C) the cost to a household of borrowing money when there is deflation
D) the opportunity cost of dining in a restaurant instead of at home
16) Which of the following is not a cost posed by inflation?
A) Inflation reduces the affordability of goods and services to the average consumer.
B) The money that consumers and firms hold loses its purchasing power.
C) Firms must pay for changing prices on products and printing new catalogs.
D) Banks can lose if they under predict inflation and charge an interest rate that does not completely
compensate for inflation.
17) The deflation of the 1930s impacted the U.S. economy because it led some consumers to ________
and because it ________.
A) postpone purchases while they waited for prices to fall even lower; increased the burden on
borrowers
B) demand higher wages in anticipation of prices eventually rising again; increased manufacturing
since firms could afford to hire more labor
C) borrow more money since money was now cheap; reduced the amount of money consumers would
have to pay back on their outstanding loans
D) increase purchases to take advantage of the falling prices; increased the burden on lenders
18) The costs to firms of changing prices are called menu costs.
19) If inflation is unanticipated, no redistribution of income can occur.
20) If inflation is anticipated, some effects of inflation on the redistribution of income can be avoided.
21) The problem with inflation is that as prices rise, consumers can no longer afford to buy as many
goods and services.
22) Inflation redistributes income to a greater extent when the inflation is unanticipated compared to
when the inflation is anticipated.
23) There are no costs to inflation if it is fully anticipated.
24) Describe how inflation can be costly even if it is anticipated.
25) When the actual inflation rate turns out to be greater than the expected inflation rate, who gains —
the borrower or the lender — and who loses? Explain why.
26) Explain whether you agree or disagree with the following statement: “The reason that inflation is
bad is because it increases the cost of living — the costs of goods and services we buy — without
increasing income in general.”
27) Explain why you would rather be a borrower during a period of unexpected rising inflation, and a
lender during a period of unexpected declining inflation.
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28) Describe how a lender can lose during inflation if the inflation is unanticipated and the loan is a
fixed-interest-rate loan. How would a variable-interest-rate loan (one that adjusts over the contract