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Econ 114 > Chapter 11 > Flashcards

Chapter 11 Flashcards

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

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2
Q

The quantity theory of money

A

Used to explain the long-run determinants of the price level and the inflation rate

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3
Q

Inflation

A

An increase in the overall level of prices

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4
Q

Define :Hyperinflation.

Inflation at over what rate?

A

An extraordinarily high rate of inflation.

Inflation exceeding 50% per month.

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5
Q

Deflation

A

Decreasing average prices

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6
Q

Over the past 60 years, prices have risen on average about __ % per year

A

4

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7
Q

Define: An economy-wide phenomenon that concerns the value of the economy’s medium of exchange

A

Inflation

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8
Q

When the overall price level rises, what happens to the value of money?

A

Its value falls

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9
Q

What does P stand for?

A

The price of a basket of goods, measured in money (Price level)

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10
Q

What is the value of $1, measured in goods? (equation)

A

1/P

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11
Q

Inflation drives up _____ and drives down __________

A

Prices

The value of money

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12
Q

What does the quantity theory of money assert?

A

That the quantity of money determines the value of money

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13
Q

What are the two approaches to the quantity theory of money?

A
  1. A supply-demand diagram

2. An equation

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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

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15
Q

What is money demand (MD)?

A

Refers to how much wealth people want to hold in liquid form

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16
Q

What does money demand depend on?

A

Depends on the price level (P)

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17
Q

An increase in P _____ the value of money, so ____ money is required to buy g&s

A

Reduces

More

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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

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19
Q

What happens when the value of money rises?

A

The price level falls

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20
Q

The Bank of Canada sets money supply (MS) at some fixed value, regardless of what?

A

The price level (P)

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21
Q

A fall in the value of money leads to an increase/decrease in P?

A

Increase

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22
Q

A fall in value of money increases the quantity of money demanded.

A

True

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23
Q

The price level (P) adjusts to equate what?

A

The quantity of money demanded with the money supply

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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

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25
Q

Increase in money supply causes the value of money (1/P) to rise.

A

False, it causes the price level (P) to rise

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26
Q

How do people get rid of their excess money? What’s the result?

A

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)

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27
Q

Nominal variables

A

Measured in monetary units

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28
Q

Three examples of nominal variables

A 
Nominal GDP
Nominal interest rate (rate of return measured in $)
Nominal wage ($/ hour worked)
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29
Q

Real variables

A

Measure in physical units

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30
Q

Three examples of real variables

A 
Real GDP
Real interest rate (measured in output)
Real wage (measured in output)
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31
Q

Relative price

A

The price of one good relative to (divided by) another

*= (X/Y) = Y per X

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32
Q

Relative prices are measured in physical units, so they are nominal variables.

A

False, so they are nominal variables

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33
Q

Whats an important relative price?

A

The real wage

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34
Q

What is real wage?

A

The price of labour relative to the price of output
= W/P
= hour/ unit of output

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35
Q

What is the variable for nominal wage (or price of labour)?

A

W

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36
Q

Classical dichotomy?

A

The theoretical separation of nominal and real variables

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37
Q

Hume and the classical economists
suggested that monetary developments
affect real variables but not nominal variables.

A

False
Nominal
Real

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38
Q

If the central bank doubles the money supply, Hume & classical thinkers contend what about the nominal and real variables?

A

Nominal variables - will double, including prices

Real variables - will remain unchanged, including relative prices

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39
Q

What is the proposition that changes in the money supply do not affect real variables?

A

Monetary neutrality

40
Q

Doubling money supply will cause all nominal and relative prices to double. (under monetary neutrality)

A

False, relative price is unchanged

41
Q

Doubling money supply will cause all nominal prices to double. Then what will happen to the real wage in monetary neutrality?

A

The real wage will remain unchanged

So.. the quantity of labour supplied, demanded, and the total employment of labour do NOT change

42
Q

Since employment of all resources is unchanged, total output is also unchanged by the money supply.

A

True

43
Q

In monetary neutrality, what will happen to employment of capital and other sources?

A

They will remain unchanged

44
Q

Most economists believe the classical dichotomy and neutrality of money describe the economy in the short run.

A

False, long run

45
Q

Velocity of money

A

The rate at which money changes hands

46
Q

What does P x Y equal?

A

= nominal GDP

OR = (price level)x(real GDP)

47
Q

Whats does M mean? V?

A 
M = money supply
V = velocity
48
Q

What is the velocity formula?

A

V = (P x Y) / M

49
Q

What is the quantity equation?

A

M x V = P x Y

50
Q

Which variable is stable in the quantity theory?

A

Velocity (V) is stable

51
Q

Quantity theory - A change in M causes _____

to change by the same percentage

A

Nominal GDP (P x Y)

52
Q

Why DOESN’T a change in the money supply (M) affect real GDP (Y)?

A

Cause money is neutral, and real GDP is determined by technology & resources

53
Q

The price level changes by the same % as what ? (2)

A
  1. Nominal GDP (P x Y)

2. Money supply (M)

54
Q

What does rapid money growth cause?

A

Rapid inflation

55
Q

If real GDP is constant, then inflation rate = money growth rate.

A

True

56
Q

If real GDP is growing, then

inflation rate > money growth rate.

A

False.

inflation rate < money growth rate.

57
Q

Economic growth increases/ decreases the # of transactions. The transactions need?

A

Increases

Needs money growth

58
Q

When might the governement print money to pay for its spending?

A

When tax revenue is inadequate and the ability to borrow is limited

59
Q

Inflation tax

A

The revenue from printing money

Printing money causes inflation, which is like a tax on everyone who holds money

60
Q

Nominal interest rate =

A

Inflation rate + Real interest rate

61
Q

How is the real interest rate determined?

A

By saving & investment in the loanable funds market

62
Q

How is inflation rate determined?

A

By the money supply growth

63
Q

In the long run, money is neutral, so a change in the money growth rate affects
_____ but not _______

A

The inflation rate

Real interest rate

64
Q

Fisher effect

A

An increase in inflation causes an equal increase in the nominal interest rate, so the real interest rate (on wealth) is unchanged.

65
Q

The inflation tax applies to people’s holdings of _____, not their holdings of ______.

A

Money

Wealth

66
Q

What its called when most people think inflation erodes real incomes?

A

Inflation fallacy

67
Q

What is a general increase in prices of the things people buy and the things they sell?

A

Inflation

68
Q

In the long run, what are real incomes determined by?

A

Real variables

69
Q

Shoeleather costs

A

The resources wasted when inflation encourages people to reduce their money holdings

70
Q

What do shoeleather costs include?

A

The time and transaction cpsts of more frequent bank withdrawls

71
Q

Menu costs

A

The costs of changing prices

72
Q

Examples of menu costs

A

printing new menus, mailing new catalogs, etc.

73
Q

Define: Firms don’t all raise prices at the same time, so relative prices can vary… which distorts the allocation of resources.

A

Misallocation of resources from relative-price variability

74
Q

Define : Inflation changes the yardstick we use to measure transactions. Which complicates long-range planning and the comparison of dollar amounts over time

A

Confusion & inconvenience

75
Q

Tax distortions

A

Inflation makes nominal income grow faster than real income

76
Q

Taxes are based on ________, and some are/ are not adjusted for inflation.

A

Nominal income

Are not adjusted

77
Q

Inflation causes people to pay _____ taxes

even when their real incomes _______.

A

More

Don’t increase

78
Q

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?

A

In both cases, the real interest rate is 10%,
so the real value of the deposit grows 10%
(before taxes)

79
Q

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?

A

1: interest income = $100, pay $25 in taxes.
2: interest income = $200, pay $50 in taxes.

80
Q

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.

A

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
Q

Inflation raises nominal interest rates and also the real interest rates.

A

False. Inflation raises nominal interest rates (Fisher effect) but not real interest rates

82
Q

Inflation decreases savers’ tax burdens.

A

False. Increases

83
Q

Inflation lowers/raises the after-tax real interest rate.

A

Lowers

84
Q

Debtors

A

Get to repay their debt with dollars that aren’t worth as much

85
Q

Arbitrary redistributions of wealth

A

Higher-than-expected inflation transfers

purchasing power from creditors to debtors

86
Q

Lower-than-expected inflation transfers purchasing power from creditors to debtors.

A

False. Debtors to creditors

87
Q

High inflation is more variable and less predictable than low inflation.

A

True

88
Q

________________________ are frequent

when inflation is high.

A

Arbitrary redistributions of wealth

89
Q

money is _____ in the ______ run, affecting only nominal variables

A

Money

Long run

90
Q

According to the quantity of money theory,

the _______ depends on the quantity of money, and the _______ depends on the money growth rate.

A

Price level

Inflation rate

91
Q

The classical dichotomy is the division of variables into ______. Long or short run?

A

real & nominal

Economists say Long run

92
Q

The neutrality of money is the idea that changes in the money supply affect ______ but not ________ Long or short run?

A

Nominal variables, but not real ones.

Economists say long run

93
Q

The inflation tax is the ____ in the real value of people’s _______ when the government causes inflation by _________

A

Loss
Money holdings
Printing money

94
Q

The Fisher effect is the one-for-one relation between?

A

Changes in the inflation rate and changes in the nominal interest rate

95
Q

What do the costs of inflation include?

A

menu costs, shoeleather costs, confusion and inconvenience, distortions in relative prices and the allocation of resources, tax distortions, and arbitrary redistributions of wealth

Econ 114 (6 decks)

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