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TutorialChapter 8 Inflation

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1. Inflation is defined as a(n)a. increase in some prices.b. increase in the price of a specific

commodity (or service).c. sustained increase in the general price level.d. sustained increase in the price of a specific

commodity (or service).

C. Not any increase in prices is considered inflation. Some prices always increase because of the workings of the price mechanism. Only when the general level of prices increase over time can we say that we have inflation.

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2. A sustained increase in the general price level is calleda. deflation.b. inflation.c. disinflation.d. hyperinflation.

B. A sustained decrease in the average price level is called deflation. Disinflation is a reduction in the rate of inflation. Hyperinflation is a very high rate of inflation.

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3. Demand-pull inflation is induced by a. inward shift in the aggregate demand curve.b. inward shift in the aggregate supply curve.c. outward shift in the aggregate supply and

demand curves.d. outward shift in the aggregate demand

curve.

D. If you draw a downward sloping demand curve and an upward sloping supply curve on a piece of paper and then move the demand curve to the right, you will see that prices will increase. This is called demand-pull inflation.

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4. Cost-push inflation is typically induced bya. inward shift in the demand curve.b. inward shift in the aggregate supply

and demand curves.c. outward shift in the demand curve.d. inward shift in the supply curve.

D. If you draw a downward sloping demand curve and an upward sloping supply curve on a piece of paper and then move the supply curve to the left, you will see that prices will increase. This is called cost-push inflation.

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5. Cost-push inflation typically follows which of the following patterns?a. Aggregate supply decreases that ultimately

causes the price level to increase.b. aggregate demand and aggregate supply

both decreases that ultimately causes the price level to increase.

A. A factor that can cause a shift in supply is a change in costs. As costs increases the supplier cannot not afford to supply as much at every price level as used to be the case. A leftward shift of the aggregate supply curve will cause prices to increase. This is called cost-push inflation.

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6. Demand-pull inflation typically follows which of the following patterns? Aggregate demanda. decreases that ultimately causes the price

level to increase.b. increases that ultimately causes the price

level to increase. c. and aggregate supply both increases that

ultimately causes the price level to increase.

B. Because the downward sloping demand curve is moving to the right along an upward sloping supply curve, the increase in demand will pull the general price level upward.

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7. The Consumer Price Index measures the cost ofa. all goods and services produced in the U.S. economy.b. all goods produced in the U.S. economy.c. a fixed market basket of consumer goods and

services produced in the U.S. economy.

C. The Consumer Price Index does not measure the prices of all goods and services, but only a particular basket of goods and services. As times change and consumers buying habits change, what goes into this basket changes.

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8. If the inflation rate is 14% per year, and your nominal income increases by 13% per year, your real incomea. declines slightly.b. increases slightly.c. increases substantially.d. does not change.

A. With inflation increasing 1% more than your income increases, your buying power, or real income, goes down by 1%.

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9. A reduction in the rate on inflation is known asa. deflation. b. disinflation.c. inflation.d. hyperinflation.

B. If inflation in year one is 6% and 5% in year two, we experience disinflation. We still have inflation in year two, but the inflation rate is lower than in the previous year.

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10. If the deflation rate is 10 percent per year, and your nominal wage rate increases by 11 percent per year, your real wage will a. increase slightly.b. increase substantially.c. not change.d. decrease slightly.

B. With a deflation rate of 10% (a fall in the average price level) and a raise in pay of 11%, your real income would rise by 21%.

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11. The real rate of interest can best be expressed as thea. nominal interest rate minus the real rate.b. inflation rate minus the nominal interest rate.c. nominal interest rate minus the inflation rate.d. inflation rate minus the real interest rate.

C. For example, in the previous question, your buying power went down by 1% because 14% minus 13% equals -1%.

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12. If the annual inflation rate is 5% per year, and the nominal interest rate is 6%, the real interest rate isa. 1% per year.b. 5% per year.c. 6% per year.d. 11% per year.

A. If you pay 6% to borrow money, but you repay the loan in dollars that have decreased in value by 5%, the true cost to you for the loan is only 1%.

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13. Which of the following would best define interest?a. Dollar amount paid to lenders to forego

consumption.b. Payment for abstinence.c. Dollar amount paid by borrowers to

lenders to forego present consumption.d. Dollar amount paid by lenders to

borrowers to forego present consumption.

C. People with money can either spend it or save it. In order to forego present consumption, these people need an incentive. The more interest they can earn on their savings, the more incentive there is to save.

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14. Megan recently borrowed money to purchase an automobile at a nominal interest rate of 8% per year. If the inflation rate is 6% per year, what is the real rate of interest on the loan? a. 6% per year.b. 8% per year.c. 4% per year.d. 2% per year.

D. By paying back an 8% loan with dollars that have been deflated by 6%, the true cost of the loan is only 2%.

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15. If future price changes were perfectly anticipated by both borrowers and lenders, what would happen to the real rate of interest in the future if the price level changed? Real interest rate would a. increase.b. decrease.c. decrease by the amount of the price increase.d. not change.

D. With future price changes exactly anticipated by both borrowers and lenders, interest rates would increase at the same level as prices, and therefore the real interest rate would not change.

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16. The misery index consists of thea. inflation rate minus the unemployment rate.b. unemployment rate minus the inflation rate.c. unemployment rate plus the inflation rate.d. unemployment rate minus the growth rate.

C. Because people are adversely affected by inflation and unemployment, to be affected by both results in real misery.

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17. The average rate of inflation during the Great Depression of the 1930s wasa. very high.b. moderate.c. zero.d. prices actually declined, we experienced

deflation not inflation.

D. The inflation rate prior to WWII was not only low but during the 1930’s we actually experienced substantial deflation because of the Great Depression.

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18. If the CPI is 220 one year and 210 the next, the annual rate of inflation is measured by the CPI is approximately a. -4.5%.b. -2.3%.c. 220%.

A. The rate of increase or decrease between two numbers is the difference between the two numbers divided by the original number. The difference between 220 and 210 is -10. Negative 10 divided by 220 is equal to a negative .045, which is -4.5%. The answer is a negative number because the CPI has decreased in this example and not increased.

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19. If the CPI is 109 one year and 112 the next, the annual rate of inflation is measured by the CPI is approximately a. 1.45%.b. 2.75%.c. 3.6%.

B. The difference between the two numbers divided by the original number is 3 / 109 = .0275 or 2.75%.

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20. Which categories are not included in the core inflation rate published by the Bureau of Labor Statistics? a. Food and energy.b. Luxury goods and automobiles.c. Computers and televisions.

A. By excluding food and energy, the two categories which increase in price the most, the government can pay out less to Social Security recipients whose payments increase along with the core inflation rate.

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21. Which categories are not included in the core inflation rate published by the Bureau of Labor Statistics? a. Food and energy.b. Luxury goods and automobiles.c. Computers and televisions.

A. By excluding food and energy, the two categories which increase in price the most, the government can pay out less to Social Security recipients whose payments increase along with the core inflation rate.

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22. In terms of monetary and fiscal policies which type of inflation is easiest to fight? a. Demand pull.b. Cost push.c. Stagflation.

A. In terms of monetary and fiscal policies we have more control over demand than we do costs.

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23. What is the best remedy for solving the problems of cost push type of inflation? a. Decrease demand.b. Lower costs in order to shift the

aggregate supply curve to the left.c. Impose a wage price freeze.

A. By giving businesses an incentive to lower their costs the aggregate supply curve can shift to the left thus driving price down and quantity up.

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24. Who can cause deep rooted long lasting inflation? a. Businesses. b. Consumers.c. The federal government.d. The Federal Reserve.

D. Only the Fed can increase the money supply more than we increase goods and services.

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25. Which is the best way to have a healthy growing economy with a low rate of inflation over a long period of time? a. Increase productivity.b. Monetize the federal debt.c. A greater centralization of power in the

hands of the federal government.

A. By increasing productivity we can have lower prices, an increase in buying power, and more employment.

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