SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. When the government of a country increases the growth rate of the money supply
2. Six costs of in’ation are: (1) shoeleather costs; (2) menu costs; (3) relative-price
variability and the misallocation of resources; (4) in’ation-induced tax distortions;
Chapter Quick Quiz
1. d
2. d
Questions for Review
1. An increase in the price level reduces the real value of money because each
2. According to the quantity theory of money, an increase in the quantity of money
3. Nominal variables are those measured in monetary units, while real variables are
4. In’ation is like a tax because everyone who holds money loses purchasing power.
485
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in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
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Chapter 30/Money Growth and In’ation ❖ 486
5. According to the Fisher e!ect, an increase in the in’ation rate raises the nominal
6. The costs of in’ation include shoeleather costs associated with reduced money
holdings, menu costs associated with more frequent adjustment of prices,
7. If in’ation is less than expected, creditors bene#t and debtors lose. Creditors
receive dollar payments from debtors that have a higher real value than was
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 30/Money Growth and In’ation ❖ 487
Problems and Applications
1. In this problem, all amounts are shown in billions.
a. Nominal GDP = P × Y = $10,000 and Y = real GDP = $5,000, so P = (P × Y )/Y
b. If M and V are unchanged and Y rises by 5%, then because M × V = P × Y, P
c. To keep the price level stable, the Fed must increase the money supply by 5%,
d. If the Fed wants in’ation to be 10%, it will need to increase the money supply
2. a. If people need to hold less cash, the demand for money shifts to the left,
b. If the Fed does not respond to this event, the shift to the left of the demand
Figure 1
c. If the Fed wants to keep the price level stable, it should reduce the money
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 30/Money Growth and In’ation ❖ 488
Figure 2
3. With constant velocity, reducing the in’ation rate to zero would require the
4. If a country’s in’ation rate increases sharply, the in’ation tax on holders of
5. a. When the price of both goods doubles in a year, in’ation is 100%. Let’s set
the market basket equal to one unit of each good. The cost of the market
b. If the price of beans rises to $2 and the price of rice rises to $4, then the cost
of the market basket in the second year is $6. This means that the in’ation
c. If the price of beans rises to $2 and the price of rice falls to $1.50, then the
d. The relative price of rice and beans matters more to Bob and Rita than the
overall in’ation rate. If the price of the good that a person produces rises
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 30/Money Growth and In’ation ❖ 489
6. The following table shows the relevant calculations:
(a) (b) (c)
(1) Nominal interest rate 10.0 6.0 4.0
(2) In’ation rate 5.0 2.0 1.0
Row (3) is row (1) minus row (2). Row (4) is 0.40 × row (1). Row (5) is (1 – .40) ×
7. The functions of money are to serve as a medium of exchange, a unit of account,
8. a. Unexpectedly high in’ation helps the government by providing higher tax
b. Unexpectedly high in’ation helps a homeowner with a #xed-rate mortgage
c. Unexpectedly high in’ation hurts a union worker in the second year of a labor
d. Unexpectedly high in’ation hurts a college that has invested some of its
9. a. The statement that “In’ation hurts borrowers and helps lenders, because
borrowers must pay a higher rate of interest,” is false. Higher expected
b. The statement, “If prices change in a way that leaves the overall price level
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 30/Money Growth and In’ation ❖ 490
c. The statement, “In’ation does not reduce the purchasing power of most
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.