Chapter 22

Question 1

When the overall price level rises,

Answer 1

the value of money falls

Question 2

What determines the value of money?

Answer 2

supply and demand

Question 3

A higher price level (a lower value of money)

Answer 3

increases the quantity of money demanded

Question 4

The horizontal axis

Answer 4

the quantity of money supplied

Question 5

Quantity theory of money

Answer 5

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 6

Quantity theory of money

Answer 6

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 . According to this theory, the quantity of money available in an economy determines the value of money, and growth in the quantity of money is the primary cause of inflation.

Question 7

Nominal variables

Answer 7

variables measures in monetary units

Question 8

Real variables

Answer 8

variables measured in physical units

Question 9

Classical dichotomy

Answer 9

the separation of real and nominal variables

Question 10

Relative price

Answer 10

the price of one thing in terms of another (the price of a bushel of corn is 2 bushels of wheat)

Question 11

The real wage( the dollar wage adjusted for inflation)

Answer 11

is a real variable because it measures the rate at which people exchange goods and services for a unit of labor

Question 12

The real interest rate (the nominal interest rate adjusted for inflation)

Answer 12

is a real variable because it measures the rate at which people exchange goods and services today for goods and services in the future

Question 13

Monetary neutrality

Answer 13

the irrelevance of monetary changes to real variables

Question 14

Velocity of money

Answer 14

the rate at which money changes hands

Question 15

Velocity of money formula

Answer 15

we divide the nominal value of output (nominal GDP) by the quantity of money. If P is the price level (the GDP deflator), Y is the quantity of output (real GDP), and M is the quantity of money.

V=(PxY)/M

MxV=PxY

Question 16

Quantity equation

Answer 16

the equation MxV=PxY, which relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services

Question 17

Equilibrium price level and inflation rate explained

Answer 17

1. the velocity of money is relatively stable over time
2. because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (PxY)
3. The economy’s output of goods and services (Y) is determined by factor supplies (labor, physical, capital, human capital, and natural resources) and the available production technology. Since money is neutral,

Question 18

Equilibrium price level and inflation rate explained

Answer 18

1. the velocity of money is relatively stable over time
2. because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (PxY)
3. The economy’s output of goods and services (Y) is determined by factor supplies (labor, physical, capital, human capital, and natural resources) and the available production technology. Since money is neutral, money does not affect output
4. Because output (Y) is fixed by factor supplies and technology, when the central bank alters the money supply (M) and induces a proportional change in the nominal value of output (PxY), this change is reflected in a change in the price level (P)
5. Therefore, when the central bank increases the money supply rapidly, the result is a high rate inflation

Question 19

Equilibrium price level and inflation rate explained. These five points are the essence of the quantity theory of money.

Answer 19

1. the velocity of money is relatively stable over time
2. because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (PxY)
3. The economy’s output of goods and services (Y) is determined by factor supplies (labor, physical, capital, human capital, and natural resources) and the available production technology. Since money is neutral, money does not affect output
4. Because output (Y) is fixed by factor supplies and technology, when the central bank alters the money supply (M) and induces a proportional change in the nominal value of output (PxY), this change is reflected in a change in the price level (P)
5. Therefore, when the central bank increases the money supply rapidly, the result is a high rate inflation

Question 20

Inflation tax

Answer 20

the revenue the government raises by creating money . It is not like the other taxes because no one receives a bill from the government for this tax. More subtle. Gov prints money, price level rises, dollars in your wallet become less valuable. Thus, the inflation tax is like a tax on everyone who holds money.

Question 21

The fischer effect

Answer 21

The one-for-one adjustment of the nominal interest rate to the inflation rate. When the Fed increases the rate of money growth, the long-run result is both a higher inflation and a higher nominal interest rate.

Question 22

The Fischer effect

Answer 22

The one-for-one adjustment of the nominal interest rate to the inflation rate. When the Fed increases the rate of money growth, the long-run result is both a higher inflation and a higher nominal interest rate.

Question 23

Shoeleather cost

Answer 23

the resources wasted when inflation encourages people to reduce their money holdings

Question 24

Menu costs

Answer 24

the cost of changing prices

Question 25

Capital gains

Answer 25

the profits made by selling an asset for more than its purchase price

Question 26

Interest income

Answer 26

The income tax treats the nominal interest earned on savings as income, even though part of the nominal interest rate merely compensates for inflation.

Question 27

6 costs of inflation

Answer 27

1. shoeleather costs associated with reduced money holdings
2. menu costs associated with more frequent adjustment of prices
3. increased variability of relative prices
4. unintended changes in tax liabilities due to nonindexation of the tax code
5. confusion and inconvenience resulting from a changing unit of account
6. arbitrary redistributions of wealth between debtors and creditors