Chapter 12- Inflation

Question 1

Inflation

Answer 1

increase in average level of prices
inflation rate= P2 - P1/P1 times 100
average change of all prices

Question 2

Indexes

Answer 2

price index- measures inflation period to period
Consumer Price Index- uses prices of several hundred thousand products
GDP deflator: ratio of nominal GDP to real GDP times 100
CPI is used to calculate real prices(price that has been adjusted for inflation)

Question 3

Quantity Theory of Money

Answer 3

M= money supply
V= velocity of money(average number of times a dollar is spent on final goods and services)
P= price level
Yr= growth(real GDP)
equal to nominal GDP
assumption #1- Yr and V are stable compared to M

Question 4

Cause of Inflation

Answer 4

caused by increase in money supply
change in velocity
decreases in velocity or in growth rate of money supply cause deflation(decrease in average level of prices, negative inflation rate)
moderate decreases lead to disinflation(drop in inflation rate)

Question 5

Costs of Inflation- #1 Price Confusion

Answer 5

makes price signals difficult to interpret
confuses increase for demand with inflation
money illusion- when people confuse changes in nominal price for changes in real price

Question 6

Costs of Inflation #2- Redistributes Wealth

Answer 6

inflation is type of tax
transfers money from citizens to government
if inflation rises, lenders are hurt and borrowers are helped
if inflation falls, lenders are helped and borrowers are hurt
real interest rate= nominal interest - inflation rate
Fisher effect- when nominal interest rates rise with expected inflation rates
monetizing the debt- when gov pays off debt by printing money
why this isn’t done– fisher effect(banks can raise interest rates), and political costs
wage agreements made years in avance
underestimating inflation- wages are too low, supply of labor too low
overestimating inflation- wages are too high, demand for labor low too low

Question 7

Costs of Inflation #3- Inflation interacts with other taxes

Answer 7

produces some tax burdens and tax liabilities

leads to people paying when they shouldn’t discourages investment

Question 8

Costs of Inflation #4- Painful

Answer 8

difficult to interpret as expectations change inflation

attempt to slow down money supply(can create a recession)