inflation and quantity theory of money

Question 1

what is CPI

Answer 1

CPI is an index of cost of a fixed market basket of goods purchased by a typical household in some base period.

CPI = nominal/real value x 100
it is weighed in a way where higher priced items count more

Question 2

what is inflation ?

Answer 2

an increase in average level of prices

Question 3

how do you calculate inflation rate?

Answer 3

(CPI 2 - CPI 1 )/ CPI 1 * 100

Question 4

what is the misery index?

Answer 4

annual median unemployment rates + consumer inflation rates

Question 5

what is hyperinflation?

Answer 5

exctremely high rates of inflation.
> 50%

Question 6

what is the qty theory of money?

Answer 6

M = qty of money
V = velocity of money
P = price level / GDP deflatotor
YR = RGDP

M x V = P x YR

Question 7

what does the qty of money theory state?

Answer 7

An increase in the qty of money leads to increase in price level

Question 8

what are the assumptions that the quantity theory of money depends on?

Answer 8

YR and V are stable
1) real GDP is stable compared to money supply
2) velocity of money is stable compared to money supply

Question 9

how does changes in velocity affect prices?

Answer 9

It can lead to hyperinflation where people spend their money faster leading to faster increase in prices
OR
fear - decreased spending - deflation - depression

Question 9

what is the relation between money supply and real GDP and how does it affect inflation? (qty theory of money)

Answer 9

if money supply > real GDP = inflation
if money supply < real GDP = deflation
if money supply = real GDP = stable price level with no inflation or deflation

Question 9

what is the formula for the growth rate of qty theory of money?

Answer 9

M + v = P + Yr
v = 0
M = growth rate of money supply
P = inflation rate
Yr = growth rate of real output

Question 9

does increase in M work in the long run or short run?

Answer 9

In short run it can boost the economy

Question 10

what is money illusion?

Answer 10

During inflation, it appears like there’s more money as it is not adjusted to real value

Question 10

what are the four problems with inflation?

Answer 10

1) price confusion and money illusion
2) inflation redistributes wealth
3) inflation interacts with other taxes
4) inflation is painful to stop

Question 10

why does the government not always inflate their debt away?

Answer 10

1) fisher effect - if banks know the government is doing this, they raise their interest rate
2) political cost - people who buy govt bonds vote

Question 10

what is redistribution of wealth?

Answer 10

if inflation rises, the lender is losing money and the borrower gains

Question 10

what is monetizing the debt?

Answer 10

when the government pays off its debts by printing their money

Question 11

what are some problems with CPI?

Answer 11

1) new product bias - excludes new products that drop in price when first released
2) changes in quality - prices could rise due to quality improvements
3) outlet bias - omits reductions in prices people pay from frequent shopping at discount stores
4) consumers substitute goods - slowly rising prices given less importance and products with pricing rising given more importance