Question 1

If your salary increased by 9 percent and prices increased by 3 percent, how much did your real wage rise by?

Accepted Answer

Real wage rise is the increase in purchasing power or the increase in the value of the salary after accounting for inflation. In this case, the nominal wage increased by 9 percent, but inflation (prices) increased by 3 percent. Therefore, the real wage rise is:

Real wage rise = (1 + nominal wage rise) / (1 + inflation rate) - 1
Real wage rise = (1 + 0.09) / (1 + 0.03) - 1
Real wage rise = 0.06 or 6 percent

So, the real wage rose by 6 percent. Therefore, the best choice is B.

Question 2

Which of the following best defines menu costs?

Accepted Answer

Menu costs refer to the cost of changing prices or menus due to inflation, and are often associated with higher inflation rates. This can include the cost of reprinting menus, updating pricing systems, and changing marketing materials to reflect new prices. Therefore, the correct option is D.

Question 3

If the nominal interest rate is 6 percent and the real interest rate is 4 percent, what is the inflation rate?

Accepted Answer

The inflation rate can be found by subtracting the real interest rate from the nominal interest rate. 
Inflation rate = Nominal interest rate - Real interest rate 
= 6% - 4% 
= 2%

Question 4

If a country had deflation of 3 percent while the nominal interest rate increased by 1 percentage point, how would the real interest rate change?

Accepted Answer

The real interest rate is calculated as the nominal interest rate minus the inflation rate. With deflation of 3% (which is negative inflation), the real interest rate increases by 3%. If the nominal rate increases by 1%, the real rate increases by a total of 4%.

Question 5

What is inflation positively correlated with?

Accepted Answer

Inflation is positively correlated with nominal wage growth because as prices rise, workers often demand higher wages to maintain their purchasing power.

Question 6

Which of the following does an increase in the money supply growth rate increase?

Accepted Answer

An increase in the money supply growth rate would lead to an increase in inflation due to a greater availability of funds leading to higher demand for goods and services, which raises prices. Nominal interest rates would also increase as lenders would seek a higher return on their loans to compensate for the inflation risk. However, real interest rates, which take inflation into account, would remain unchanged as the inflation increase would cancel out the nominal rate increase.

Question 7

In the long run, when money is neutral, which of the following increases when the money supply growth rate increases?

Accepted Answer

In the long run, money is neutral, meaning it does not affect real variables like real output growth or real interest rates. However, an increase in the money supply growth rate leads to higher inflation, which increases nominal interest rates due to the Fisher effect.

Question 8

Suppose that velocity and output are constant and that the quantity theory and Fisher effect are both correct. If the nominal interest rate is 4 percent and inflation is 2 percent, what is the money supply growth rate or the real interest rate?

Accepted Answer

According to the quantity theory of money, if velocity and output are constant, the money supply growth rate equals the inflation rate, which is 2 percent.

Question 9

What do shoe leather costs refer to?

Accepted Answer

Shoe leather costs refer to the resources used to maintain lower money holdings when inflation is high. This means people will have to frequently visit the bank or ATM to withdraw cash, which costs time and effort, like walking in uncomfortable shoes (hence the term "shoe leather").

Question 10

What can a country increase in the long run by increasing its money growth rate?

Accepted Answer

Increasing the money growth rate will lead to an increase in the price level in the long run. This is known as the quantity theory of money, where the money supply growth rate is directly proportional to the inflation rate. However, there is no direct relationship between money growth rate and real output, real interest rates or the nominal wage divided by the price level.

Question 11

What does the Fisher effect imply?

Accepted Answer

The Fisher effect implies that the nominal interest rate adjusts one for one with the inflation rate, meaning that if inflation increases, the nominal interest rate will increase by the same amount to maintain the real interest rate.

Question 12

Cole puts money into an account. One year later, he sees that he has 4 percent more dollars and that his money will buy 3 percent more goods. Which of the following is consistent with these facts?

Accepted Answer

If Cole’s money increased by 4 percent over the year and the goods he buys cost 3 percent more at the end of the year, he has experienced a net gain of 1 percent in his purchasing power. That means that the inflation rate was 1 percent. To get the nominal interest rate, we add the inflation rate to the real interest rate, so Cole must have earned a 4 percent nominal interest rate and a 3 percent real interest rate, implying a 1 percent inflation rate. Therefore, answer choice A is the correct answer.

Question 13

Suppose that velocity and output are constant, the quantity theory and Fisher effect are correct, the nominal interest rate is 14 percent, and money growth is 6 percent. Which statement is consistent with these facts?

Accepted Answer

Given the Fisher effect, the real interest rate can be calculated by subtracting the inflation rate from the nominal interest rate. If the quantity theory of money is correct and velocity is constant, then the inflation rate is equal to the money growth rate, which is 6 percent. Therefore, the real interest rate is 14 percent (nominal interest rate) minus 6 percent (inflation rate), which equals 8 percent. Since the question states that output is constant, it implies that if nominal wages are rising, it is likely due to inflation, making option C correct.

Question 14

If the money supply growth rate permanently increased from 5 percent to 25 percent, what would we expect to happen to inflation?

Accepted Answer

According to the quantity theory of money, inflation is directly related to the growth rate of the money supply. Therefore, if the money supply growth rate permanently increased from 5 percent to 25 percent, we would expect inflation to increase by 20 percentage points (25% - 5% = 20%). Therefore, the correct answer is B.

Question 15

Tashonna puts money in a savings account at her bank, earning 4.5 percent. One year later, she takes her money out and notes that while her money was earning interest, prices rose 2.5 percent. How has the amount of goods Tashonna can buy changed one year later?

Accepted Answer

Tashonna's money grew by 4.5 percent due to interest, but because prices rose by 2.5 percent, the real increase in her purchasing power is the difference between these two rates, which is 2 percent more goods.

Question 16

What does the shoe leather cost of inflation refer to?

Accepted Answer

Shoe leather costs refer to the increased costs and effort of managing cash holdings and making more frequent bank transactions to avoid holding money that is losing value due to inflation.

Question 17

What terms refers to the cost of changing price tags and price listings?

Accepted Answer

The term that refers to the cost of changing price tags and price listing is menu costs.

Question 18

If the money supply growth rate permanently increased from 4 percent to 10 percent, what would we expect to happen to the inflation rate and the nominal interest rate?

Accepted Answer

According to the quantity theory of money, a permanent increase in the money supply growth rate leads to a proportional increase in the inflation rate. The Fisher effect suggests that nominal interest rates adjust to expected inflation, so both the inflation rate and nominal interest rate would increase by 6 percent.

Question 19

Which inflation cost matters even if actual inflation and expected inflation are the same?

Accepted Answer

Menu costs refer to the actual cost of changing prices due to inflation, such as the cost to reprint menus or update signage. These costs still exist even if actual and expected inflation are the same, making option D the correct choice. Production costs, losses in real income, and losses in tax revenue are all affected by differences between actual and expected inflation.

Question 20

People use more resources to reduce their money holdings because of high inflation. What is this an example of?

Accepted Answer

This is an example of shoe leather costs, which refers to the increased costs (such as time and effort) of managing money holdings due to high inflation.

Quiz 11: Money Growth and Inflation