Chapter 15

Question 1

This chapter deals with one of the most important concepts in macroeconomics

Answer 1

Price level

Question 2

Definition of Inflation and what is deflation

Answer 2

An overall rise in prices in the economy ; deflation is an overall fall in prices in the economy

Question 3

What is Core Inflation and how does this differ from all items inflation?

Answer 3

a measure of inflation that excludes goods with historically volatile prices;

all items inflation include all of the goods that the average consumer buys

Question 4

Definition of the aggregate price level

Answer 4

a measure of the average price level for GDP

Question 5

Definition of the neutrality of money

Answer 5

the idea that real outcomes in the economy are not affected by aggregate price levels

Question 6

The classical theory of inflation

Answer 6

states that in the long run, increases in money supply will lead to an increase in prices only ; in the long run only prices increase - we know this from the AD/AS model

Question 7

the quantity theory of money

Answer 7

states that the value of money that the value of money is determined by the money supply; can be seen mathematically through the quantity equation of MxV = PxY
V= velocity of money; the number of times that the entire money supply turns over in a given period
This theory depends on V being relatively constant
V = (PxY) / M
P = price level
Y = Real output

Question 8

What does a money velocity of 2 mean?

Answer 8

that each dollar in the money supply was spent 2x on average in order to generate $1000

Question 9

costs of predictable inflation

Answer 9

menu costs
shoe leather costs
tax distortion - refers to the fact that tax laws only take into consideration nominal income, not actual purchasing power of that money eg) being penalized by inflation since you’re in a different tax bracket since you make more money but inflation has actually changed your purchasing power

Question 10

What is the nominal interest rate?

Answer 10

the reported interest rate that is not adjusted for the effects of inflation

Question 11

What is the real interest rate?

Answer 11

the real interest rate is adjusted for the effects of inflation
real interest rate = nominal interest - inflation rate

Question 12

Inflation and borrowers

Answer 12

high inflation is good because you pay back less than the amount you borrowed; the value of savings and debts decreases - this is bad for savers, because their money is worth less but great for borrowers

Question 13

What is deflation?

Answer 13

a sustained fall in the aggregate price level
causes aggregate demand to decrease - increases the burden of debt which leads to a decrease in consumption

when aggregate demand decreases, the burden of debt increases which leads to a decrease in consumption; companies are less willing to borrow money which leads to a decrease in investment

Inflation reduces the risk of this

Question 14

What is disinflation?

Answer 14

a period where inflation rates are falling but still positive - occurs when the central bank tries to contain inflation via contractionary monetary policy

Question 15

What is hyperinflation?

Answer 15

extremely long lasting and painful increases in the price level; this can leave currency completely valueless or close to it

Question 16

What is an economy’s potential output?

Answer 16

the total amount of output a country could produce if all of its resources were fully engaged

Question 17

What is an output gap?

Answer 17

when actual ouput is different than potential output.
Negative output - potential is below; this means that there’s alot of resources, everyone’s waiting for work, small threat of inflation, borrowers don’t want money because they can’t pay it back since no one is working

positive - working above capacity; alot of people are employed, employees are working alot and demand high pay; lots of investment happening in factors of production

Question 18

What can the central bank engage in to increase employment

Answer 18

expansionary monetary policy; the bank increases money and lowers interest rates. This increases borrowing which can help the economy rebound; this increase demand for g/s will put upward pressure on prices only in the short run

Question 19

What is the philips curve?

Answer 19

model that shows the connection between inflation and unemployment in the short run;

indicates that prices increase at a faster rate when unemployment is low; when unemployment increases, prices start to slow

an increasein AD results in an increase in price and output in the short run ; the philips curve shows that this is related with higher inflation and lower unemployment

Question 20

What does the philips curve fail to consider?

and what do economists implement to change this

Answer 20

inflation expectations;
people will expect whatever inflation has prevailed to continue
eg) when the bank of canada wants to do expansionary monetary policy, inflation (from the philips curve) will keep unemployment low however things in the long run go back keeping prices high.

THe NAIRU is implemented; aka the non aceclerating inflation rate of unemployment

Question 21

What is the NAIRU?

Answer 21

a vertical line in the philips curve indicating that if unemployment is below the NAIRU, inflation accelerates;

it’s also known as the natural rate of unemployment, or where the lowest rate of unemployment can be in a city