Question 1

Suppose that reducing inflation 3 percentage points would cost a country 15 percent of annual output.What is this country's sacrifice ratio?

Accepted Answer

The sacrifice ratio is calculated by dividing the percentage loss in output by the percentage reduction in inflation. Here, 15% loss in output divided by 3% reduction in inflation equals a sacrifice ratio of 5.

Question 2

Proponents of rational expectations theory have argued that,in the most extreme case,if policymakers are credibly committed to reducing inflation,and if rational people understand that commitment and quickly lower their inflation expectation,the sacrifice ratio could be as small as what?

Accepted Answer

Proponents of rational expectations theory argue that if policymakers are credible in reducing inflation and people understand their commitment, then inflation expectations will quickly adjust. This would result in a lower sacrifice ratio, potentially as low as 0, meaning that no output loss would be required to reduce inflation.

Question 3

If the Bank of Canada announced a policy to reduce inflation and people found it credible,what would happen to the short-run Phillips curve and the sacrifice ratio?

Accepted Answer

If the Bank of Canada's policy to reduce inflation is credible, people will adjust their inflation expectations downward. This leads to a leftward shift in the short-run Phillips curve, as lower inflation expectations reduce wage and price pressures. The sacrifice ratio, which measures the cost of reducing inflation in terms of lost output, would fall because the credible policy reduces the need for high unemployment to fight inflation.

Question 4

Which theory proposes that people optimally use all available information when forecasting the future?

Accepted Answer

The rational expectations theory suggests that people use all available information to make their predictions about the future. This means that they take into account all relevant economic data, past trends, and other factors that may impact future outcomes.

Question 5

Suppose an economy with high inflation decides to decrease the money supply growth rate.Which of the following best describes the results?

Accepted Answer

When the economy decreases the money supply growth rate, it leads to a decrease in demand, causing a decrease in output and an increase in unemployment in the short run. This means there is a movement along the existing short-run Phillips curve, shifting it upwards (to the right) due to the increase in unemployment. In the long run, however, the decrease in demand leads to reduced inflation, which shifts the short-run Phillips curve downwards (to the left). Therefore, the initial effect is an increase in unemployment and a movement along the existing curve, but eventually, the short-run Phillips curve shifts leftward due to the decrease in inflation.

Question 6

The long-run response to a decrease in the growth rate of the money supply is shown by shifting which of the Phillips curves and in what direction?

Accepted Answer

The answer of The long-run response to a decrease in...

Question 7

How much was the unemployment rate in Canada in 1983?

Accepted Answer

According to Statistics Canada, the unemployment rate in Canada was 11.0 percent in 1983.

Question 8

Which of the following best defines the sacrifice ratio?

Accepted Answer

The sacrifice ratio is the number of percentage points annual output falls for each percentage point reduction in inflation. It measures the short-term costs of reducing inflationary pressures by sacrificing output and increasing unemployment.

Question 9

Proponents of rational expectations theory have argued that the sacrifice ratio could be as small as what?

Accepted Answer

Proponents of rational expectations theory have argued that the sacrifice ratio could be as small as 0, indicating that there is no need to sacrifice short-term output in order to reduce inflation. This is because if individuals have rational expectations, they will adjust their behavior in response to changes in monetary policy, leading to a more efficient and less costly adjustment process.

Question 10

Suppose the Bank of Canada reduces inflation 2 percentage points,and this makes output fall 10 percentage points and unemployment rises 4 percentage points.What is the sacrifice ratio?

Accepted Answer

The sacrifice ratio is calculated as the loss in output divided by the reduction in inflation. Here, the output falls by 10 percentage points and inflation is reduced by 2 percentage points, so the sacrifice ratio is 10/2 = 5.

Question 11

Suppose the Bank of Canada decreased the growth rate of the money supply.What would permanently decrease?

Accepted Answer

A decrease in the growth rate of the money supply would lead to a lower inflation rate in the long run, as there would be less money chasing the same amount of goods and services.

Question 12

Suppose the Bank of Canada reduces the rate of inflation by 4 percentage points.Suppose,as well,that the sacrifice ratio has a value of 2.5.Which of the following describes what happens to GDP?

Accepted Answer

The sacrifice ratio indicates the percentage loss in GDP for each percentage point reduction in inflation. With a sacrifice ratio of 2.5, a 4 percentage point reduction in inflation would lead to a 10 percentage point decrease in GDP (4 x 2.5 = 10).

Question 13

If the sacrifice ratio is 3,reducing the inflation rate from 10 percent to 5 percent would require sacrificing what percent of annual output?

Accepted Answer

The sacrifice ratio is the percentage of annual output lost to reduce inflation by 1 percentage point. With a sacrifice ratio of 3, reducing inflation by 5 percentage points (from 10% to 5%) would require sacrificing 15% of annual output (3 x 5 = 15).

Question 14

Which statement best characterizes the theory of rational expectations?

Accepted Answer

The theory of rational expectations concerns how people use information to predict the future. It suggests that individuals will use all available information in forming their expectations, including information about government policies, and will adjust their behavior accordingly.

Question 15

What did proponents of rational expectations argue about the sacrifice ratio and why?

Accepted Answer

Proponents of rational expectations argued that the sacrifice ratio could be low because people might adjust their expectations quickly if they found anti-inflation policy credible. This is because rational individuals will incorporate all available information, including government actions, into their expectations about inflation. Therefore, if the government takes credible anti-inflationary measures, individuals will adjust their expectations accordingly, leading to a smaller sacrifice ratio.

Question 16

Which statement best defines disinflation?

Accepted Answer

Disinflation is a decrease in the rate of inflation. It means that prices are still rising, but at a slower rate than before. It is not the same as deflation (negative rate of inflation) or zero inflation.

Question 17

Which statement best describes the sacrifice ratio for Canada?

Accepted Answer

Studies suggest that Canada's sacrifice ratio falls over a range of 2 to 5. This means that for every 1% reduction in inflation, there could be a reduction in output by 2 to 5 percentage points.

Question 18

Suppose a central bank reduced inflation by 4 percentage points and that made output fall by 5 percentage points for four years,and it made the unemployment rate rise from 3 percent to 9 percent for three years.What is the sacrifice ratio?

Accepted Answer

The sacrifice ratio is calculated as the total loss in output divided by the reduction in inflation. Here, the total loss in output is 5 percentage points for four years, which is 20 percentage points. The reduction in inflation is 4 percentage points. So, the sacrifice ratio is 20/4 = 5.

Question 19

Ultimately,what causes the short-run reduction in unemployment associated with an increase in inflation?

Accepted Answer

The short-run reduction in unemployment associated with an increase in inflation is due to unanticipated inflation, not inflation per se. As inflation increases, firms may increase production in the short run to meet the increased demand for goods and services. This increase in production may lead to a reduction in unemployment. However, if inflation is anticipated, workers and firms will adjust their behavior accordingly, leading to no reduction in unemployment in the short run.

Question 20

If the sacrifice ratio is 3,reducing the inflation rate from 10 percent to 7 percent would require sacrificing how much annual output?

Accepted Answer

The sacrifice ratio of 3 means that for every percentage point reduction in inflation, 3% of annual output must be sacrificed. In this case, reducing inflation from 10% to 7% requires a 3 percentage point reduction, which means sacrificing 3 x 3% = 9% of annual output. Therefore, the answer is C, sacrificing 9% of annual output.

Quiz 16: The Short-Run Tradeoff Between Inflation and Unemployment