chapter 7

Question 1

What does the equation of exchange do?

Answer 1

shows the relationship between prices and the money supply

Question 2

What is the equation of exchange?

Answer 2

MV=PQ (M=money supply. P=price level. Q=amount of output produced by the economy-fixed.)

Question 3

What does the V stand for in the equation of exchange?

Answer 3

V=velocity. The average number of times a dollar changes hands in a year. Fixed over a short period of time.

Question 4

Common sense interpretation of the equation of exchange?

Answer 4

a year’s worth of output in the economy is bought by the money supple which is spent and respent V times per year.

Question 5

Where does inflation come from?

Answer 5

When the Fed and banks increase the money supply

Question 6

How can all consumers spend more on all goods and services without their nominal savings?

Answer 6

money supply must have increased

Question 7

Which assumptions does the simple quantity theory rest on?

Answer 7

The equation of exchange applies. Velocity is constant. Output is constant.

Question 8

What is the prediction of the simple quantity theory?

Answer 8

money supply and price level are proportionally related

Question 9

What assumptions does monetarism make about the equation of exchange?

Answer 9

Velocity is a stable function of a few variables. Output may change in the short run, but in the long run, output is at the economy’s potential, with labor markets at equilibrium. Equation of exchange holds.

Question 10

What happens in the short run and the long run with Friedman’s helicopter drop?

Answer 10

short run: prices/output increase.

longrun: wages increase, output at economy’s potential, but with increasing prices.

Question 11

Under what conditions would inflation have zero effect on the economy?

Answer 11

If it is wholly anticipated and evenly spread throughout the economy.

Question 12

If all prices in the economy double, how does the qatnity of goods/services produced change?

Answer 12

it doesn’t change.

Question 13

What is a way to avoid being made worse off by anticipated inflation?

Answer 13

Buy goods/services whose prices inflate before inflation starts.

Question 14

Who gains and loses with anticipated inflation?

Answer 14

borrowers gain and lenders lose

Question 15

real interest rate

Answer 15

nominal rate - expected inflation rate

Question 16

secured loan

Answer 16

loan where lender can seize the borrower’s property if not paid. backed by a real, collateral asset

Question 17

What are 2 problems with uneven inflation?

Answer 17

Prices no longer reflect value, so mistakes are made. Bubbles expand as systematic mistakes are made due to the inflation.

Question 18

When someone pays an interest rate to someone, what are they paying that person to do?

Answer 18

to delay the consumption

Question 19

The economic school that emphasized inflationary bubbles?

Answer 19

Austrian school of economics with Hayes and Mises

Question 20

What is the difference between dollars saved and dollars created by the Fed?-

Answer 20

Dollars saved have the potential to fuel later consumption, since they represent delayed consumption. Dollars made by the Fed do not have this potential.

Question 21

What happens when a Fed-created inflationary bubble bursts?-

Answer 21

Unwanted capital goods and and constructions are abandoned and the workers that produced them must all find new jobs.

Question 22

Why do the Austirans say that government and the central bank create bubbles, though private markets do not?

Answer 22

Because there must be coordinated failures by many individuals and firms. Government, especially through a government money supplier is the best coordinator

Question 23

What is “monetizing the debt?”

Answer 23

The central bank attempts to assist the state in its borrowing by purchasing debt in return for dollars

Question 24

What is the inflationary tax?

Answer 24

When money growth causes inflation, borrowers gain and lenders lose, so governments, who borrow a lot, can sap their lenders by creating inflation and paying with lower valued dollars.

Question 25

What was the difference between inflation using gold as money and inflation using dollars not backed by gold?

Answer 25

Inflation using gold was very low. Inflation using unbacked dollars was high

Question 26

What was the cause of inflation in the late 1960s?

Answer 26

The Fed’s monetizing of the debt to support the Vietnam War

Question 27

How much inflation is viewed as normal?

Answer 27

3%

Question 28

With 3% inflation, how long does it take the value of one’s savings to be cut in half?-

Answer 28

24 years

Question 29

What is an example of an unsecured loan?

Answer 29

Credit Cards- high risk because there is no actual asset backing the loan; they are more expensive because it costs the company more to administer the credit card. The payments vary and the charges continue to pile up and be paid off.