Chapter 17

Question 1

Inflation

Answer 1

Increase in the overall level of prices

Question 2

Deflation

Answer 2

Decrease in the overall level of prices

Question 3

Disinflation

Answer 3

Decrease in the inflation rate

Question 4

Hyperinflation

Answer 4

Extraordinarily high rate of inflation

Question 5

Classical theory of money

Answer 5

1. Quantity theory of money
2. Explain the long-run determinants of the price level
3. Explain the inflation rate

Question 6

Inflation: rise in the price level

Answer 6

1. Lower value of money

2. Each dollar buys a smaller quantity of goods and services

Question 7

Money demand

Answer 7

Reflects how much wealth people want to hold in liquid form

Demand curve – downward sloping

Question 8

Money supply

Answer 8

Determined by the Fed and the banking system

Supply curve is vertical

Question 9

The Fed Doubles Money Supply

Answer 9

1. Supply curve shifts right
2. Value of money decreases
3. Price level increases

Question 10

Quantity theory of money

Answer 10

1. The quantity of money available in the economy determines (the value of money) the price level
2. Growth rate in quantity of money available determines the inflation rate

Question 11

Nominal variables

Answer 11

Variables measured in monetary units

EX.)Dollar prices

Question 12

Real variables

Answer 12

Variables measured in physical units

EX.)Relative prices, real wages, real interest rate

Question 13

Classical dichotomy

Answer 13

1. Influence nominal variables

2. Irrelevant for explaining real variables

Question 14

Monetary neutrality

Answer 14

Changes in money supply don’t affect real variables

Question 15

Velocity of money (V)

Answer 15

V = (P × Y) / M
P = price level (GDP deflator)
Y = real GDP
M = quantity of money

Rate at which money changes hands
Average number of times a dollar has been spent in a year

Relatively stable over time

Question 16

Quantity equation

Answer 16

M × V = P × Y

Question 17

Quantity Theory of Money

Answer 17

M × V = P × Y
Y = (M × V)/P

In a demand side recession output falls and there is pressure on prices to decrease
Increases in money supply M do not increase prices in the short run
Velocity of money is not always constant
Increasing the money supply can lead to short run increases in output

Question 18

The inflation tax

Answer 18

Revenue the government raises by creating (printing) money

Like a tax on everyone who holds money

Question 19

Fisher Effect

Answer 19

Real interest rate = Nominal interest rate – Inflation rate

Nominal interest rate = Real interest rate + Inflation rate

Question 20

Fisher effect:When the Fed increases the rate of money growth

Answer 20

Long-run result
Higher inflation rate
Higher nominal interest rate

Question 21

Shoeleather costs

Answer 21

Resources wasted when inflation encourages people to reduce their money holdings

Question 22

Menu Costs

Answer 22

Costs of changing prices

Question 23

Market Economies:Inflation

Answer 23

1.Inflation distorts relative prices
A)Consumer decisions are distorted
B)Markets are less able to allocate resources to their best use

Question 24

Higher Inflation

Answer 24

Increases the Tax Burden

Question 25

When the Fed increases money supply

Answer 25

Creates Inflation

Decreases the Value of Money

Question 26

Unexpected inflation

Answer 26

Redistributes wealth among the population
Not by merit
Not by need
Redistribute wealth among debtors and creditors

Question 27

The Friedman rule: moderate deflation will

Answer 27

Lower the nominal interest rate
Reduce the cost of holding money
Shoeleather costs of holding money - minimized by a nominal interest rate close to zero
Deflation equal to the real interest rate

Question 28

Costs of deflation

Answer 28

Menu costs
Relative-price variability
If not steady and predictable
Redistribution of wealth toward creditors and away from debtors
Arises because of broader macroeconomic difficulties
Symptom of deeper economic problems