ch.31

Question 1

How does the money supply affect inflation?

Answer 1

An increase in money supply leads to higher inflation as the excess money causes increased demand for goods and services.

Question 2

Does the money supply affect real variables like real GDP?

Answer 2

No, the money supply primarily affects nominal variables, while real variables remain unchanged.

Question 3

What is the principle of inflation as a tax?

Answer 3

Inflation acts like a tax by eroding the purchasing power of money held by individuals.

Question 4

What are the costs of inflation?

Answer 4

Costs include shoeleather costs, menu costs, misallocation of resources, and tax distortions.

Question 5

What is the price level in economic terms?

Answer 5

The price level can be viewed as the price of a basket of goods and services or as a measure of the value of money.

Question 6

What does the quantity theory of money assert?

Answer 6

It asserts that the quantity of money determines the price level and its growth rate determines the inflation rate.

Question 7

What is monetary equilibrium?

Answer 7

It is the point where money supply equals money demand, determining the equilibrium price level.

Question 8

Define classical dichotomy.

Answer 8

It is the theoretical separation of nominal variables from real variables.

Question 9

What is monetary neutrality?

Answer 9

It is the proposition that changes in the money supply do not affect real variables.

Question 10

What is the velocity of money?

Answer 10

The rate at which money changes hands within the economy.

Question 11

What does the quantity equation relate?

Answer 11

It relates the quantity of money, the velocity of money, and the dollar value of the economy’s output.

Question 12

List the five steps of the quantity theory.

Answer 12

• Velocity is stable over time
• Change in money supply causes nominal GDP to change by the same percentage
• Change in money supply does not affect real GDP
• Changes in money supply and nominal GDP are reflected in price level
• Rapid money supply growth causes rapid inflation

Question 13

What defines hyperinflation?

Answer 13

Hyperinflation is generally defined as inflation exceeding 50% per month.

Question 14

What is seigniorage?

Answer 14

The profit generated from the difference between the cost of producing money and its face value.

Question 15

What is the Fisher effect?

Answer 15

It states that the nominal interest rate adjusts one-for-one with changes in the inflation rate.

Question 16

True or False: Inflation erodes real incomes.

Answer 16

False. Real incomes are determined by real variables, not the inflation rate.

Question 17

What are shoeleather costs?

Answer 17

Resources wasted when inflation encourages people to reduce their money holdings.

Question 18

What are menu costs?

Answer 18

The costs associated with changing prices.

Question 19

What is meant by tax distortions due to inflation?

Answer 19

Inflation causes nominal income to grow faster than real income, leading to higher taxes.

Question 20

Fill in the blank: The inflation tax is essentially a tax on everyone who holds _______.

Answer 20

money

Question 21

What happens to nominal prices when the money supply is doubled?

Answer 21

All nominal prices will double, but relative prices remain unchanged.

Question 22

What is the after-tax nominal interest rate for CASE 1?

Answer 22

7.5%

CASE 1: Nominal = 0.75 x 10% = 7.5%

Question 23

What is the after-tax nominal interest rate for CASE 2?

Answer 23

15%

CASE 2: Nominal = 0.75 x 20% = 15%

Question 24

What is the after-tax real interest rate for CASE 1?

Answer 24

7.5%

CASE 1: Real = 7.5% – 0% = 7.5%

Question 25

What is the after-tax real interest rate for CASE 2?

Answer 25

5% ## Footnote CASE 2: Real = 15% – 10% = 5%

Question 26

In which case do you pay the most taxes?

Answer 26

CASE 2 ## Footnote CASE 2: interest income = $200, so you pay $50 in taxes

Question 27

In which case does the real value of your deposit grow the most?

Answer 27

Both cases ## Footnote Real interest rate is 10% for both cases

Question 28

What are the costs of inflation?

Answer 28

* Menu costs * Shoeleather costs * Confusion and inconvenience * Distortions in relative prices * Misallocation of resources * Tax distortions * Arbitrary redistributions of wealth ## Footnote These costs arise from the effects of inflation on economic transactions and wealth distribution.

Question 29

What is deflation?

Answer 29

A decline in price levels ## Footnote Deflation can lead to menu costs and relative-price variability.

Question 30

What does the quantity theory of money explain?

Answer 30

The price level depends on the quantity of money ## Footnote The inflation rate depends on the money growth rate.

Question 31

What is the classical dichotomy?

Answer 31

The division of variables into real and nominal ## Footnote This concept separates the effects of monetary changes on real variables from those on nominal variables.

Question 32

What is the neutrality of money?

Answer 32

Changes in the money supply affect nominal variables but not real ones ## Footnote This implies that in the long run, money does not affect real economic variables.

Question 33

What is the inflation tax?

Answer 33

The loss in the real value of people’s money holdings due to inflation ## Footnote This occurs when the government prints money, causing inflation.

Question 34

What is the Fisher effect?

Answer 34

The one-for-one relation between changes in the inflation rate and changes in the nominal interest rate ## Footnote This concept illustrates how nominal interest rates adjust to inflation.