Question 1

The problem associated with inflation is that as prices rise, consumers can no longer afford to buy as many goods and services, since nominal income usually does not increase with inflation.

Accepted Answer

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Question 2

Explain whether you agree or disagree with the following statement: "The reason that inflation is bad is because it increases the cost of living-the costs of goods and services we buy-without increasing income in general."

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Question 3

Inflation redistributes income to a greater extent when the inflation is unanticipated compared to when the inflation is anticipated.

Accepted Answer

When inflation is unanticipated, individuals and businesses may not have adjusted their spending and pricing behavior, leading to greater distortions in the economy and more significant redistributions of income. When inflation is anticipated, individuals and businesses may have already adjusted their behavior, and the redistributive effects may be less pronounced.

Question 4

There are no costs to inflation if it is fully anticipated.

Accepted Answer

Even if inflation is fully anticipated, there are still costs such as menu costs (the costs of changing prices), shoe leather costs (the costs associated with more frequent transactions or withdrawals of money), and the distortions it can cause in taxation and savings.

Question 5

If inflation is unanticipated, no redistribution of income can occur.

Accepted Answer

Unanticipated inflation can cause redistribution of income as it can benefit borrowers (who have fixed-rate debts) and harm lenders (who are receiving a fixed interest rate). Additionally, it can affect the purchasing power of different income groups differently, leading to changes in their relative welfare.

Question 6

Explain why you would rather be a borrower during a period of unexpected rising inflation, and a lender during a period of unexpected declining inflation.

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Question 7

Describe how inflation can be costly even if it is anticipated.

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Question 8

If inflation is anticipated, some effects of inflation on the redistribution of income can be avoided.

Accepted Answer

If inflation is anticipated, individuals and businesses can adjust their behavior by reducing their spending or increasing their savings, which can help to mitigate the negative effects of inflation on their income and wealth. Additionally, inflation-indexed assets such as Treasury Inflation-Protected Securities (TIPS) can help protect investors from inflation. Therefore, in such a scenario, some effects of inflation on the redistribution of income can be avoided.

Question 9

Describe how a lender can lose during inflation if the inflation is unanticipated and the loan is a fixed-interest-rate loan. How would a variable-interest-rate loan (one that adjusts over the contract period) eliminate these loses?

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Question 10

When the actual inflation rate turns out to be greater than the expected inflation rate, who gains-the borrower or the lender-and who loses? Explain why.

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Quiz 20: Unemployment and Inflation