Chapter 16

Question 1

Inflation

Answer 1

An increase in the overall level of prices

Question 2

Deflation

Answer 2

A fall in the overall level of prices

Question 3

The inflation rate is the percentage change in the:

Answer 3

1. CPI
2. GDP deflator
3. Other index of overall price level

Question 4

Core Inflation

Answer 4

Excludes goods with historically volatile price changes

Question 5

All-items inflation (headline inflation)

Answer 5

Includes all of the goods that the average consumer buys

Question 6

What two ways can the economy’s overall pice level be viewed

Answer 6

1. As the price of a basket of goods and services

2. As a measure of the value of money

Question 7

Level of prices in the economy

Answer 7

The overall level of prices adjusts to the level at which demand for money equals the supply

Question 8

What are the effects of momentary injection

Answer 8

1. Short run- output and prices rise
2. Workers want higher wage
3. Long run- more money supply will lead to higher prices; output stays the same

Question 9

Quantity theory of money

Answer 9

A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate

Question 10

What are real variables

Answer 10

Variables measured in physical units

Question 11

What is classical dichotomy

Answer 11

The theoretical separation of nominal and real variables

Question 12

What is monetary neutrality

Answer 12

The proposition that changes in the money supply do not affect real variables

Question 13

What is the quantity equation

Answer 13

MV = PY

V: velocity of money
Y: Real GDP
P: Price level
M: quantity of money

Question 14

What is the velocity of money

Answer 14

The number of times that the entire money supply turns over in a given period

Question 15

What does the quantity equation imply

Answer 15

That increasing the money supply leads to inflation and decreasing the money supply leads to deflation

Leads to the conclusion that price level is immaterial

Question 16

What are menu costs

Answer 16

The money, time, and opportunity costs of changing prices to keep up with inflation

Question 17

What are shoe leather costs

Answer 17

The time, money, and effort costs of managing cash in the face of inflation

Question 18

What is Tax distortion

Answer 18

The fact that tax laws only take into consideration nominal income, not what you can buy with it

Question 19

What is the nominal interest rate

Answer 19

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

Question 20

What is the real interest rate

Answer 20

Adjusted for the effects of inflation

Question 21

Equation for real interest rate

Answer 21

Real interest rate = Nominal interest rate - inflation rate

Question 22

What is the aggregate price level

Answer 22

A measure of the average price level; in practice, the CPI or GDP price deflator

Question 23

What are menu costs

Answer 23

The costs of changing prices to keep pace with inflation

Question 24

What is disinflation

Answer 24

A period in which inflation rates are falling but still positive

Question 25

What is hyperinflation

Answer 25

Extremely long lasting and painful increases in the price level

Question 26

What is potential output

Answer 26

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

Question 27

What is the Phillips curve and what does it show

Answer 27

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

It shows that a decrease in unemployment will be accompanied by an increase in inflation in the short run

Question 28

What is the NAIRU

Answer 28

The lowest possible unemployment rate that will not cause the inflation rate level to increase

Question 29

What does it mean for output gap to be positive

Answer 29

Competition leads to a rise in the prices of inputs, which means inflation increases

Question 30

What does it mean if the output gap is negative

Answer 30

Resources are not being fully used. Inflation decreases so central banks will peruse expansionary monetary policy by lowering interest rates, allowing inflation to rise and brining back employment

Question 31

What does statistics Canada use to measure inflation

Answer 31

Core inflation because it is less likely to reflect shocks to individual product markets and more likely to show economy wide inflation

Question 32

What does the neutrality of money imply

Answer 32

That if money supply suddenly doubled, nominal GDP would double as well, but real GDP would stay the same

Question 33

Why do policy makers prefer small amounts of inflation

Answer 33

• little inflation reduces the risk of deflation
• leaves more room for the central bank to engage in expansionary monetary policy
• easier for firms to adjust real wages in response to changing labour demand and supply conditions

Question 34

What will happen if the central bank pursues aggressive expansionary policy to reduce unemployment

Answer 34

Inflation may spiral out of control. The level of unemployment at which inflation will remain unstable is called the non-accelerating inflation rate of unemployment (NAIRU)

Question 35

What is the classical theory of inflation

Answer 35

In the long run, increases in money supply lead to increase in money supply only

In the short run, output and prices increase as aggregate demand shifts to the right