Chapter 16: Inflation

Question 1

What is inflation and deflation?

Answer 1

inflation: an increase in the overall price level, money becomes worthless

Deflation: a fall in the overall pricelevel: harmful for firms

Question 2

Nominal vs real inflation rate

Answer 2

Real: prices before inflation

Nominal: prices added with inflation using GDP deflator

Question 3

2 ways of measureing inflation

Answer 3

all items inflation: all G+S that the average person buys

Core inflation - volitile, energy and food

Question 4

what is the classical theory of inflation?

Answer 4

when the value of money decreases, inflation happens.
money looses its store value

Question 5

how is the value of money determined?

Answer 5

through money supply: BOC

through money demand: people wanting liquidity.
- depends on price levels.
- in the LR, price levels adjsut to the demand for money.

Question 6

what is monetary injection?

Answer 6

when the BOC puts money into the economy making the dollar worth less.
Short run: prices increase and output increases.

Long run: workers want higher wages
higher prices, same output - causes inflation

Question 7

What is the quantity theory of money used for?

Answer 7

how price levels are determined and how they change over time.
quantity of money available determines the price level.
growth rate of #money determines the inflation rate.

M x V = P x Y

Velosity is stable

Question 8

What is monetary neutrality?

Answer 8

if you change quanity of money in the economy, it affects prices, but have no effect on output in the long run.
Neutrality: when prices go up, wages go up as well.

if money supply doubles, nominal GDP would double, but not Real GDP

• large economic changes are bad

Question 9

predictable costs of inflation

Answer 9

1. menu costs
   - the costs associated with changing prices
   - time money oppertunity
2. shoe-leather costs
   - managing cash
3. tax distortion costs (bracket creep)
   -this happens when tax laws only take into consideration nominal income - not what you can buy with that income

Question 10

unpredictable costs of inflation

Answer 10

Nominal interest rate - inflation rate = real interest rate (adjusted for inflation)

changes in prices affect interest rates

Question 11

what is Deflation?

Answer 11

A sustained fall in the price level
not good for production.
benefits the spender at the cost of the borrower
decrease in consumption and investment - loans are more expensive to pay back

Question 12

Disinflation

Answer 12

inflation is falling but still positive
when the central bank trys to contain inflation through contracitonary monetary policy
shift left

Question 13

Hyperinflation

Answer 13

extreme infltaion = high price levels
currency becomes valueless

Question 14

How does inflation protect deflation?

Answer 14

through monetary policy: small changes are better than bigger ones

makes it easier for rism to adjust real wages, without affecting productivity by changing labour demand conditions

Question 15

Monetary policy & inflation

Answer 15

it is hard to maintain stable prices and full employment

Potential output: total amount of output a country could produce if all of its resouces were fully Engaged. (no cyclical unemployment)

output gap = inflation
more output = less unemployment
less output = more unemployment

Question 16

what is the phillips curve?

Answer 16

it measures the comparison between inflation and unemployment.
lower inflation = more unemployment
higher inflation = less unemployment

Question 17

phillips curve in the long run

Answer 17

there is no trade off between inflation and unemployment

output and unemployment return to earlier equlibrium

Question 18

Non-accelerating inflation rate of unemployment NAIRU

Answer 18

minimum level of unemployment - full employment

inflation goes up if unemployment is belowe the NAIRU

it can change over time due to structural employment