Chapter 11 Flashcards
(95 cards)
1
Q
What do economists believe about the quantity theory of money?
A
It’s a good explanation of the long run behaviour of inflation
2
Q
The quantity theory of money
A
Used to explain the long-run determinants of the price level and the inflation rate
3
Q
Inflation
A
An increase in the overall level of prices
4
Q
Define :Hyperinflation.
Inflation at over what rate?
A
An extraordinarily high rate of inflation.
Inflation exceeding 50% per month.
5
Q
Deflation
A
Decreasing average prices
6
Q
Over the past 60 years, prices have risen on average about __ % per year
A
4
7
Q
Define: An economy-wide phenomenon that concerns the value of the economy’s medium of exchange
A
Inflation
8
Q
When the overall price level rises, what happens to the value of money?
A
Its value falls
9
Q
What does P stand for?
A
The price of a basket of goods, measured in money (Price level)
10
Q
What is the value of $1, measured in goods? (equation)
A
1/P
11
Q
Inflation drives up _____ and drives down __________
A
Prices
The value of money
12
Q
What does the quantity theory of money assert?
A
That the quantity of money determines the value of money
13
Q
What are the two approaches to the quantity theory of money?
A
- A supply-demand diagram
2. An equation
14
Q
In the money supply-demand model, we assume that BoC controls what?
A
Controls the money supply and sets it at some fixed amount
15
Q
What is money demand (MD)?
A
Refers to how much wealth people want to hold in liquid form
16
Q
What does money demand depend on?
A
Depends on the price level (P)
17
Q
An increase in P _____ the value of money, so ____ money is required to buy g&s
A
Reduces
More
18
Q
Thus, quantity of money demanded is positively /negatively related to the value of money and positively/negatively related to P, other things equal
A
Negatively
Positively
19
Q
What happens when the value of money rises?
A
The price level falls
20
Q
The Bank of Canada sets money supply (MS) at some fixed value, regardless of what?
A
The price level (P)
21
Q
A fall in the value of money leads to an increase/decrease in P?
A
Increase
22
Q
A fall in value of money increases the quantity of money demanded.
A
True
23
Q
The price level (P) adjusts to equate what?
A
The quantity of money demanded with the money supply
24
Q
If the BoC increases the money supply, what happens to the value of money (1/P) and the price level (P)?
A
The value of money falls
The price level rises
25
Increase in money supply causes the value of money (1/P) to rise.
False, it causes the price level (P) to rise
26
How do people get rid of their excess money? What's the result?
By spending it on goods and services OR by loaning it to others (who spend it)
Result: increased demand for goods
*(supply of goods does not increase, so price must rise)*
27
Nominal variables
Measured in monetary units
28
Three examples of nominal variables
```
Nominal GDP
Nominal interest rate (rate of return measured in $)
Nominal wage ($/ hour worked)
```
29
Real variables
Measure in physical units
30
Three examples of real variables
```
Real GDP
Real interest rate (measured in output)
Real wage (measured in output)
```
31
Relative price
The price of one good relative to (divided by) another
| *= (X/Y) = Y per X
32
Relative prices are measured in physical units, so they are nominal variables.
False, so they are nominal variables
33
Whats an important relative price?
The real wage
34
What is real wage?
The price of labour relative to the price of output
= W/P
= hour/ unit of output
35
What is the variable for nominal wage (or price of labour)?
W
36
Classical dichotomy?
The theoretical separation of nominal and real variables
37
Hume and the classical economists
suggested that monetary developments
affect real variables but not nominal variables.
False
Nominal
Real
38
If the central bank doubles the money supply, Hume & classical thinkers contend what about the nominal and real variables?
Nominal variables - will double, including prices
| Real variables - will remain unchanged, including relative prices
39
What is the proposition that changes in the money supply do not affect real variables?
Monetary neutrality
40
Doubling money supply will cause all nominal and relative prices to double. (under monetary neutrality)
False, relative price is unchanged
41
Doubling money supply will cause all nominal prices to double. Then what will happen to the real wage in monetary neutrality?
The real wage will remain unchanged
| So.. the quantity of labour supplied, demanded, and the total employment of labour do NOT change
42
Since employment of all resources is unchanged, total output is also unchanged by the money supply.
True
43
In monetary neutrality, what will happen to employment of capital and other sources?
They will remain unchanged
44
Most economists believe the classical dichotomy and neutrality of money describe the economy in the short run.
False, long run
45
Velocity of money
The rate at which money changes hands
46
What does P x Y equal?
= nominal GDP
| OR = (price level)x(real GDP)
47
Whats does M mean? V?
```
M = money supply
V = velocity
```
48
What is the velocity formula?
V = (P x Y) / M
49
What is the quantity equation?
M x V = P x Y
50
Which variable is stable in the quantity theory?
Velocity (V) is stable
51
Quantity theory - A change in M causes _____
| to change by the same percentage
Nominal GDP (P x Y)
52
Why DOESN'T a change in the money supply (M) affect real GDP (Y)?
Cause money is neutral, and real GDP is determined by technology & resources
53
The price level changes by the same % as what ? (2)
1. Nominal GDP (P x Y)
| 2. Money supply (M)
54
What does rapid money growth cause?
Rapid inflation
55
If real GDP is constant, then inflation rate = money growth rate.
True
56
If real GDP is growing, then
| inflation rate > money growth rate.
False.
| inflation rate < money growth rate.
57
Economic growth increases/ decreases the # of transactions. The transactions need?
Increases
| Needs money growth
58
When might the governement print money to pay for its spending?
When tax revenue is inadequate and the ability to borrow is limited
59
Inflation tax
The revenue from printing money
| Printing money causes inflation, which is like a tax on everyone who holds money
60
Nominal interest rate =
Inflation rate + Real interest rate
61
How is the real interest rate determined?
By saving & investment in the loanable funds market
62
How is inflation rate determined?
By the money supply growth
63
In the long run, money is neutral, so a change in the money growth rate affects
_____ but not _______
The inflation rate
| Real interest rate
64
Fisher effect
An increase in inflation causes an equal increase in the nominal interest rate, so the real interest rate (on wealth) is unchanged.
65
The inflation tax applies to people’s holdings of _____, not their holdings of ______.
Money
| Wealth
66
What its called when most people think inflation erodes real incomes?
Inflation fallacy
67
What is a general increase in prices of the things people buy and the things they sell?
Inflation
68
In the long run, what are real incomes determined by?
Real variables
69
Shoeleather costs
The resources wasted when inflation encourages people to reduce their money holdings
70
What do shoeleather costs include?
The time and transaction cpsts of more frequent bank withdrawls
71
Menu costs
The costs of changing prices
72
Examples of menu costs
printing new menus, mailing new catalogs, etc.
73
Define: Firms don’t all raise prices at the same time, so relative prices can vary… which distorts the allocation of resources.
Misallocation of resources from relative-price variability
74
Define : Inflation changes the yardstick we use to measure transactions. Which complicates long-range planning and the comparison of dollar amounts over time
Confusion & inconvenience
75
Tax distortions
Inflation makes nominal income grow faster than real income
76
Taxes are based on ________, and some are/ are not adjusted for inflation.
Nominal income
| Are not adjusted
77
Inflation causes people to pay _____ taxes
| even when their real incomes _______.
More
| Don't increase
78
You deposit $1000 in the bank for one year.
1: inflation = 0%, nom. interest rate = 10%
2: inflation = 10%, nom. interest rate =20%
Assume the tax rate = 25%
a) In which case does the real value of your deposit grow the most?
In both cases, the real interest rate is 10%,
so the real value of the deposit grows 10%
(before taxes)
79
You deposit $1000 in the bank for one year.
1: inflation = 0%, nom. interest rate = 10%
2: inflation = 10%, nom. interest rate =20%
Assume the tax rate = 25%
b) In which case do you pay the most taxes?
1: interest income = $100, pay $25 in taxes.
2: interest income = $200, pay $50 in taxes.
80
You deposit $1000 in the bank for one year.
1: inflation = 0%, nom. interest rate = 10%
2: inflation = 10%, nom. interest rate =20%
Assume the tax rate = 25%
Compute the after-tax nominal interest rate, then subtract off inflation to get the after-tax real interest rate for both cases.
1: nominal = 0.75 x 10% = 7.5%
real = 7.5% – 0% = 7.5%
2: nominal = 0.75 x 20% = 15%
real = 15% – 10% = 5%
81
Inflation raises nominal interest rates and also the real interest rates.
False. Inflation raises nominal interest rates (Fisher effect) but not real interest rates
82
Inflation decreases savers' tax burdens.
False. Increases
83
Inflation lowers/raises the after-tax real interest rate.
Lowers
84
Debtors
Get to repay their debt with dollars that aren’t worth as much
85
Arbitrary redistributions of wealth
Higher-than-expected inflation transfers
| purchasing power from creditors to debtors
86
Lower-than-expected inflation transfers purchasing power from creditors to debtors.
False. Debtors to creditors
87
High inflation is more variable and less predictable than low inflation.
True
88
________________________ are frequent
| when inflation is high.
Arbitrary redistributions of wealth
89
money is _____ in the ______ run, affecting only nominal variables
Money
| Long run
90
According to the quantity of money theory,
| the _______ depends on the quantity of money, and the _______ depends on the money growth rate.
Price level
| Inflation rate
91
The classical dichotomy is the division of variables into ______. Long or short run?
real & nominal
| Economists say Long run
92
The neutrality of money is the idea that changes in the money supply affect ______ but not ________ Long or short run?
Nominal variables, but not real ones.
| Economists say long run
93
The inflation tax is the ____ in the real value of people’s _______ when the government causes inflation by _________
Loss
Money holdings
Printing money
94
The Fisher effect is the one-for-one relation between?
Changes in the inflation rate and changes in the nominal interest rate
95
What do the costs of inflation include?
menu costs, shoeleather costs, confusion and inconvenience, distortions in relative prices and the allocation of resources, tax distortions, and arbitrary redistributions of wealth
