Question 1

Suppose the nominal interest rate charged is 5 percent and the expected inflation rate is 2 percent.Which of the following is the expected real interest rate?
A) 2 percent
B) 5 percent
C) 7 percent
D) -3 percent
E) 3 percent

Accepted Answer

The expected real interest rate can be calculated as the nominal interest rate minus the expected inflation rate. Therefore, the expected real interest rate in this scenario would be 5 percent - 2 percent = 3 percent. So, option E is the correct answer.

Question 2

If you believe that the inflation rate is likely to be high over the next ten years,you would want to
A) have a pension with raises indexed to the CPI if you were going to be retiring
B) obtain a variable rate mortgage
C) not obtain any fixed rate consumer loans
D) pay off all of your existing fixed rate loans
E) be a shareholder of a bank because their profits are going to increase dramatically

Accepted Answer

Having a pension with raises indexed to the CPI would ensure that your income increases in line with inflation, providing protection against its effects for the long-term. Obtaining a variable rate mortgage or not obtaining fixed rate consumer loans may not be the best options as higher inflation could lead to higher interest rates, making it more expensive to pay off loans. Paying off existing fixed-rate loans might be a good idea, but it depends on the interest rates of those loans. Being a shareholder of a bank may or may not be a good option, as the impact on their profits may depend on inflation's effect on the overall economy.

Question 3

Which of the following statements about unanticipated inflation is true?
A) It reduces average purchasing power in the economy.
B) It reduces total purchasing power in the economy.
C) It redistributes purchasing power in the economy.
D) It reduces nominal wages.
E) Its effects are spread evenly throughout the economy so that no one gains or loses from inflation.

Accepted Answer

Unanticipated inflation redistributes purchasing power in the economy. Some individuals or groups gain while others lose. For example, borrowers benefit as they pay back loans with dollars that are worth less, while lenders lose. Similarly, workers with fixed nominal wages lose, while firms with pricing power can increase their prices to maintain profits. Therefore, it does not reduce total purchasing power in the economy nor reduce nominal wages, and its effects are not spread evenly throughout the economy.

Question 4

Inflation is harmful to society because it often
A) causes consumers' purchasing power to decline
B) causes sellers' costs to increase
C) causes nominal wages to fall
D) causes purchasing power to be redistributed in haphazard ways
E) has no effect at all on anyone's purchasing power

Accepted Answer

The answer of Inflation is harmful to society because it...

Question 5

A decline in real income
A) can occur only if there is a decline in nominal income
B) can occur only if there is an increase in the price level
C) can occur only if there is either a decline in nominal income or an increase in the price level
D) cannot occur if there is either an increase in nominal wages or a decline in the price level
E) can occur only if there is a decline in the price level

Accepted Answer

Real income is adjusted for inflation, so a decline in real income can occur if there is either a decline in nominal income (without a matching decrease in prices) or an increase in the price level (without a matching increase in nominal income). Therefore, both of these factors contribute to a decline in real income, making choice C the correct answer. None of the other choices fully capture the various factors that can lead to a decline in real income.

Question 6

Parvez is trying to decide whether or not he should lend $1,000 to Eli for a year.Eli would pay a fixed nominal interest rate of 8 percent.Parvez expects the inflation rate to be 4 percent for the year.If he does not lend the $1,000 to Eli,Parvez will purchase an indexed savings bond that pays an interest rate of 4 percent,or he will put the money in a (nonindexed)savings account earning 6 percent.Parvez
A) will earn 4 percent in real terms if he loans Eli the money,0 percent in real terms if he buys the bond,and 6 percent in real terms if he puts the money into a savings account
B) is better off holding his money as cash
C) is indifferent between lending the money to Eli and buying the bond because the real interest rate is the same in either case
D) should purchase the bond because it earns the highest real rate of interest
E) earns the highest real rate of interest if he puts his $1,000 into a savings account

Accepted Answer

The real interest rate for lending to Eli is 4% (8% nominal - 4% inflation). The bond's real interest rate is also 4% (4% nominal - 0% inflation). Therefore, Parvez is indifferent between lending to Eli and buying the bond.

Question 7

Everything else constant,who is least likely to lose from unexpected inflation?
A) A retired person whose pension payments are fixed in dollars
B) A person with a large amount of money deposited in a savings account
C) A bank scheduled to receive fixed nominal mortgage payments
D) A homeowner scheduled to make fixed nominal mortgage payments
E) A consumer who spends extra time shopping for the lowest prices

Accepted Answer

A homeowner with fixed nominal mortgage payments benefits from unexpected inflation because the real value of their payments decreases, making it easier to pay off the mortgage.

Question 8

Lorrie will receive a nominal wage increase of 10 percent this year.The inflation rate was 5 percent last year and is predicted to be 8 percent this year.If the economic forecast is correct,her real wage this year
A) will increase by approximately 2 percent
B) will increase by approximately 8 percent
C) will increase by approximately 5 percent
D) will remain the same
E) cannot be calculated without knowing the number of dollars by which her wage increases

Accepted Answer

To calculate the real wage increase, we need to adjust the nominal wage increase for inflation.

Real wage increase = Nominal wage increase - inflation rate

Nominal wage increase is 10 percent

Inflation rate last year was 5 percent, so the inflation rate this year will be 8 - 5 = 3 percent higher than last year.

Real wage increase = 10% - 3% = 7%

Therefore, Lorrie's real wage will increase by approximately 7%.

Question 9

Your friend Shahla argues that inflation is bad for the economy because it lowers everyone's purchasing power.How would an economist respond to Shahla's statement?
A) Her statement is true.
B) Her statement is false because inflation redistributes income but does not change the average level of income in the economy.
C) Her statement is true when everyone's nominal income changes by the same amount.
D) Her statement is true when wages and benefits are not indexed to the CPI.
E) Her statement is true only in a closed economy.

Accepted Answer

Inflation does not decrease everyone's purchasing power equally. It leads to a redistribution of income, but does not change the average level of income in the economy. Some groups, such as those whose incomes rise with inflation (such as employees working under a cost-of-living adjusted contract), may experience increased purchasing power. Meanwhile, those whose incomes do not rise with inflation (such as individuals on a fixed income) experience a decline in purchasing power. Therefore, Shahla's statement is too simplistic and does not account for the different effects of inflation on different individuals or groups within the economy.

Question 10

If inflation is higher than anticipated and benefits are not indexed,which group loses purchasing power?
A) Borrowers and lenders
B) Lenders and retirees
C) Borrowers and retirees
D) Only borrowers
E) Only lenders

Accepted Answer

Lenders lose because they receive payments in money that is worth less than expected. Retirees lose purchasing power if their benefits are not indexed to inflation, as their fixed income buys less.

Question 11

If there are no restrictions on contracts,and if all parties in the economy accurately predict the rate of inflation over the next year,then
A) there will be no redistribution of purchasing power
B) purchasing power will be redistributed from wage earners to business owners
C) purchasing power will be redistributed from business owners to wage earners
D) purchasing power will be redistributed from lenders to borrowers
E) purchasing power will be redistributed from borrowers to lenders

Accepted Answer

If all parties accurately predict the rate of inflation, then they will factor it in their contracts and negotiations. This means that there will be no unexpected surprises or redistributions of purchasing power as everyone will have understood the consequences of the inflation rate. Therefore, there will be no need for any specific redistribution.

Question 12

Suppose the economy includes two distinct groups of people: wage earners and goods sellers.If the price level increases by 50 percent and nominal wages remain unchanged,
A) there will be no redistribution of purchasing power because all private wage earners in the U.S.economy receive indexed wages
B) real wages will remain the same because nominal wages do not change
C) there will be no redistribution of purchasing power because only changes in real income can change the distribution of income
D) income will be redistributed from wage earners to goods sellers
E) income will be redistributed from goods sellers to wage earners

Accepted Answer

When the price level increases and nominal wages remain unchanged, the real purchasing power of wage earners decreases, leading to a redistribution of income from wage earners to goods sellers.

Question 13

A labor union anticipates a 7 percent inflation rate in each of the next three years.It wants to obtain a 3 percent increase in real wages in each of those three years.To obtain this goal,the requisite nominal wage hike it should negotiate is
A) 7 percent each year
B) 3 percent each year
C) 10 percent each year
D) 10 percent the first year and 3 percent each year thereafter
E) 21 percent the first year and 3 percent each year thereafter

Accepted Answer

To achieve a 3% increase in real wages with a 7% inflation rate, the nominal wage increase should be 10% each year (7% to cover inflation + 3% real increase).

Question 14

Economists widely agree that the Consumer Price Index (CPI)understates the true U.S.inflation rate.

Accepted Answer

The answer of Economists widely agree that the Consumer Price...

Question 15

To approximate the percentage change in real income over any period of time,
A) we need to subtract the percentage change in nominal income from the inflation rate
B) we need to subtract the rate of inflation from the percentage change in nominal income
C) we need to divide the percentage change in nominal income by the inflation rate
D) we need to multiply the change in income by the inflation rate
E) we need to multiply the nominal percentage change in income by the percentage change in inflation rate

Accepted Answer

To calculate the percentage change in real income, we need to adjust for inflation. This means we need to subtract the rate of inflation from the percentage change in nominal income. Therefore, choice B is the correct answer.

Question 16

If inflation is fully anticipated and if there are no restrictions on contracts,then inflation will not redistribute purchasing power.

Accepted Answer

In an economy where inflation is fully anticipated and there are no restrictions on contracts, individuals and businesses will adjust their behavior accordingly, and inflation will not have any redistributive effects on purchasing power. Therefore, the answer is A.

Question 17

The real interest rate on a loan
A) is the amount that the consumer agrees to pay
B) is always the same as the nominal rate
C) is always greater than the nominal rate
D) is only of concern when serious inflation occurs
E) is the percentage increase in the lender's purchasing power that results from making the loan

Accepted Answer

The real interest rate on a loan is the percentage increase in the lender's purchasing power that results from making the loan. It takes into account the effects of inflation on the loan, whereas the nominal rate only reflects the stated interest rate. The real interest rate can be greater or less than the nominal rate, depending on the inflation rate.

Question 18

Jim is negotiating a contract for a labor union.The union wants to increase members' real wages by 4 percent.The inflation rate is predicted to be 7 percent.To attain the union's goal,Jim needs to negotiate a raise in the nominal
A) wage of 4 percent
B) wage of 7 percent
C) wage of 11 percent
D) rate of 3 percent
E) rate of 28 percent

Accepted Answer

To increase members' real wages by 4 percent means to increase their wages by the inflation rate plus the desired increase in wages, which is:

(1 + inflation rate) x (1 + desired increase) = 1 + real wage increase

Plugging in the given values, we get:

(1 + 0.07) x (1 + 0.04) = 1 + 0.11

This means that to achieve the union's goal of a 4 percent increase in real wages, Jim needs to negotiate a raise in the nominal wage of 11 percent (Choice C).

Question 19

If inflation is perfectly anticipated,benefits are indexed,and there are no restrictions on contracts,which group loses purchasing power because of inflation?
A) Borrowers,lenders and retirees
B) Only borrowers
C) Neither lenders,borrowers,nor retirees
D) Only lenders
E) Only retirees

Accepted Answer

If inflation is perfectly anticipated, benefits are indexed, and there are no restrictions on contracts, then all parties can adjust their behavior accordingly. Borrowers can adjust the interest rate they are willing to pay to account for expected inflation, lenders can adjust the interest rate they are willing to charge for the same reason, and retirees can adjust their savings behavior to account for the expected changes in prices. As a result, no group loses purchasing power because of inflation.

Question 20

Suppose the economy consists of two distinct groups: wage earners and goods sellers.If the price level increases by 30 percent and real wages increase by 30 percent,
A) there will be no redistribution of purchasing power between goods sellers and wage earners
B) purchasing power will be redistributed from wage earners to goods sellers
C) purchasing power will be redistributed from goods sellers to wage earners
D) nominal wages will increase by 90 percent
E) nominal wages will decrease by 60 percent

Accepted Answer

The answer of Suppose the economy consists of two distinct...

Quiz 7: The Price Level and Inflation

Suppose the nominal interest rate charged is 5 percent and the expected inflation rate is 2 percent.Which of the following is the expected real interest rate?

If you believe that the inflation rate is likely to be high over the next ten years,you would want to

Which of the following statements about unanticipated inflation is true?

Inflation is harmful to society because it often

A decline in real income

Everything else constant,who is least likely to lose from unexpected inflation?

Lorrie will receive a nominal wage increase of 10 percent this year.The inflation rate was 5 percent last year and is predicted to be 8 percent this year.If the economic forecast is correct,her real wage this year

Your friend Shahla argues that inflation is bad for the economy because it lowers everyone's purchasing power.How would an economist respond to Shahla's statement?

If inflation is higher than anticipated and benefits are not indexed,which group loses purchasing power?

If there are no restrictions on contracts,and if all parties in the economy accurately predict the rate of inflation over the next year,then

Suppose the economy includes two distinct groups of people: wage earners and goods sellers.If the price level increases by 50 percent and nominal wages remain unchanged,

A labor union anticipates a 7 percent inflation rate in each of the next three years.It wants to obtain a 3 percent increase in real wages in each of those three years.To obtain this goal,the requisite nominal wage hike it should negotiate is

Economists widely agree that the Consumer Price Index (CPI)understates the true U.S.inflation rate.

To approximate the percentage change in real income over any period of time,

If inflation is fully anticipated and if there are no restrictions on contracts,then inflation will not redistribute purchasing power.

The real interest rate on a loan

Jim is negotiating a contract for a labor union.The union wants to increase members' real wages by 4 percent.The inflation rate is predicted to be 7 percent.To attain the union's goal,Jim needs to negotiate a raise in the nominal

If inflation is perfectly anticipated,benefits are indexed,and there are no restrictions on contracts,which group loses purchasing power because of inflation?

Suppose the economy consists of two distinct groups: wage earners and goods sellers.If the price level increases by 30 percent and real wages increase by 30 percent,