Question 1

Inflation tends to cause nominal wages to:
A) increase.
B) decrease.
C) remain constant.
D) become more difficult to predict.

Accepted Answer

Inflation tends to cause nominal wages to increase, as workers demand higher wages to compensate for the increase in the cost of living.

Question 2

The primary reason we think of inflation as bad even when wages rise with it is that it:
A) makes things more expensive for consumers.
B) leads to lower real wages.
C) distorts the information delivered by prices.
D) increases the velocity of money.

Accepted Answer

Inflation distorts the information delivered by prices, making it difficult for consumers and businesses to make informed decisions, even if wages rise with inflation.

Question 3

High volatility in the inflation rate can result in:
A) improper allocation of resources.
B) sudden changes in output.
C) low volatility in the CPI.
D) deflation.

Accepted Answer

High volatility in the inflation rate can lead to improper allocation of resources because businesses and consumers may not be able to accurately predict future prices, which can lead to inefficient investment and consumption decisions.

Question 4

When people suffer from money illusion,an increase in the money supply:
A) raises real GDP in the short run.
B) lowers real GDP in the short run.
C) has no effect on real GDP in the short run but raises real GDP in the long run.
D) lowers real GDP in the long run.

Accepted Answer

When people suffer from money illusion, they believe that an increase in the money supply increases their wealth even though the price level has increased. As a result, in the short run, they tend to spend more and increase the demand for goods and services, leading to an increase in real GDP. However, in the long run, prices will adjust and the money illusion will be corrected, leading to lower real GDP as the increase in the money supply leads to inflation.

Question 5

When the money supply and the demand for goods increase at the same time:
A) producers understand how to react,but consumers are confused.
B) consumers act rationally,but producers cannot read the market signals.
C) the government is able to clarify how the markets will be affected.
D) both consumers and producers can often become confused.

Accepted Answer

Both consumers and producers can often become confused when both the money supply and demand for goods increase at the same time. Consumers may be uncertain about how much to spend and on what, while producers may not be sure about how much to produce and at what price to sell their goods. This can lead to market volatility and fluctuations in prices.

Question 6

Money illusion is a condition in which people:
A) see money as an illusion for value.
B) expect the value of money will illusively surge.
C) mistakenly confuse changes in nominal GDP for changes in real GDP.
D) mistakenly confuse changes in nominal prices for changes in real prices.

Accepted Answer

Money illusion is a phenomenon where people believe changes in nominal prices (the actual dollar amount) are indicative of changes in real prices (the purchasing power of the dollar). Therefore, they mistake changes in nominal prices for changes in real prices.

Question 7

Suppose you are forced to take a pay cut of 5% when the economy is experiencing overall deflation of 5%.If in response to your pay cut you also reduce your consumption by 5%,then economists would say:
A) you made a rational decision.
B) you are exhibiting money illusion.
C) your real wage decreased by 5%.
D) the quantity theory of money held.

Accepted Answer

By reducing consumption in response to the pay cut, you are exhibiting money illusion - a tendency for people to confuse nominal monetary values (such as wages or prices) with real values (which take into account changes in the purchasing power of money). In reality, your real wage has decreased by 5% due to the combination of the pay cut and deflation.

Question 8

Inflation hurts the economy because:
A) it raises all prices in the economy.
B) it affects the ability of market prices to send signals about the value of resources.
C) all can perfectly see the increases in prices.
D) higher prices reduce real output.

Accepted Answer

Inflation distorts price signals, making it difficult for consumers and producers to make informed decisions about resource allocation, which can lead to inefficiencies in the economy.

Question 9

Because of money illusion,inflation usually confuses:
A) consumers.
B) workers.
C) firms.
D) consumers,workers,and firms.

Accepted Answer

Money illusion, referring to the tendency to think of currency in nominal rather than real terms, can affect all economic players. Inflation typically causes confusion among consumers and workers, as they may not immediately recognize the erosion of their purchasing power. Firms may also be affected, as they must consider the impact of inflation on production costs and pricing decisions. Therefore, all choices are valid answers.

Question 10

Which of the following is an example of money illusion assuming that inflation is 5%?
A) You receive a 5% raise at your part-time job and start spending extra money on entertainment every weekend.
B) You receive a 5% raise at your part-time job but do not increase or decrease your spending.
C) You do not receive a raise at your part-time job but cut out some expenses as you notice some prices rising.
D) You receive a 10% raise at your part-time job and start spending extra money on entertainment every weekend.

Accepted Answer

Money illusion occurs when people mistake nominal changes for real changes. In this case, the 5% raise is nominal and does not account for inflation. Therefore, assuming that prices have gone up by 5%, the increase in income is actually only keeping up with inflation and not providing any real increase in purchasing power. By increasing spending on entertainment without adjusting for inflation, the person is experiencing money illusion.

Question 11

Mistaking changes in nominal prices for changes in real prices is called a:
A) nominal illusion.
B) real illusion.
C) price illusion.
D) money illusion.

Accepted Answer

Mistaking changes in nominal prices for changes in real prices is called money illusion. Money illusion is where people think in terms of nominal dollars, rather than the real value of those dollars, when considering changes in their standard of living.

Question 12

Money illusion occurs when people:
A) become irrational about money use.
B) become rationally ignorant about money.
C) mistake changes in prices for changes in quality.
D) mistake changes in nominal prices for changes in real prices.

Accepted Answer

Money illusion occurs when people mistake changes in nominal prices (the actual price of a good or service) for changes in real prices (the purchasing power of money). This phenomenon often occurs during periods of inflation, where nominal prices increase due to changes in the money supply, but the real value of money decreases. People may mistakenly believe that their incomes have increased or decreased, without realizing that the change in nominal prices has affected the real value of their money.

Question 13

When an economy experiences volatile and unpredictable hyperinflation:
A) people will decrease their borrowing.
B) people will increase their lending.
C) borrowing and lending won't be affected.
D) it causes a breakdown of financial intermediation.

Accepted Answer

Hyperinflation causes people to lose faith in the currency, leading to a breakdown in financial intermediation. This means that lending and borrowing will become nearly impossible as banks and other financial institutions will be hesitant to provide loans in a highly inflationary environment. Therefore, option D is the correct choice.

Question 14

Which of the following is a problem with deflation?
A) It raises the real cost of debt repayment.
B) Stopping it will cause a recession.
C) It causes people to pay more taxes.
D) There is no problem with deflation;falling prices are good for the economy.

Accepted Answer

Deflation raises the real cost of debt repayment because it increases the value of money over time, making it more expensive to pay back debts contracted at earlier times with higher-valued money.

Question 15

When changes in nominal prices are confused with changes in real prices,people experience:
A) consumer bias.
B) inflationary delusion.
C) cyclical price confusion.
D) money illusion.

Accepted Answer

When changes in nominal prices are confused with changes in real prices, people experience money illusion. Money illusion occurs when people mistake changes in nominal prices for changes in real prices, leading to incorrect assumptions about their purchasing power. For example, if someone's wages increase by 2% but inflation is also 2%, they may think they are better off, but in reality, their purchasing power has not changed. This confusion between nominal and real prices is known as money illusion.

Question 16

Money illusion occurs when people:
A) correctly see changes in nominal prices.
B) correctly see changes in real prices.
C) see changes in real prices and mistake them for changes in nominal prices.
D) see changes in nominal prices and mistake them for changes in real prices.

Accepted Answer

Money illusion occurs when people mistake changes in nominal prices for changes in real prices. This means that they are not fully aware of the effects of inflation or deflation on the purchasing power of their money. They may be focused on the numerical value of prices rather than the value of what those prices can buy.

Question 17

High and volatile inflation:
A) causes the price of goods and services to deviate from the market price.
B) increases the purchasing power of money and income.
C) creates high supply of goods and services.
D) destroys the ability of market prices to send signals about the value of resources and opportunities.

Accepted Answer

High and volatile inflation destroys the ability of market prices to send signals about the value of resources and opportunities. As prices become more unpredictable, market participants become unable to make informed decisions about resource allocation and investment, leading to economic inefficiencies and distortions in the allocation of resources.

Question 18

Jordan loaned Taylor $1,200 on March 15,2009.Taylor returned $1,260 on March 14,2010.Inflation was 2% over the 1-year period.What is the real interest rate that Taylor paid?
A) 2%
B) 3%
C) 5%
D) 7%

Accepted Answer

The answer of Jordan loaned Taylor $1,200 on March 15,2009.Taylor...

Question 19

Which of the following is NOT a cost of inflation?
A) price confusion
B) declining wages
C) money illusion
D) inflation tax

Accepted Answer

Inflation can lead to declining purchasing power, price confusion, money illusion, and inflation tax. However, declining wages are not necessarily a cost of inflation as wages may increase alongside the inflation rate.

Question 20

The concept of money illusion refers to:
A) people who do not understand the purchasing power of money and therefore spend it faster than they can earn it.
B) consumers with inflation-indexed wages seeing a rise in prices and believing that their purchasing power has been compromised.
C) consumers paying prices that are higher than normal and not feeling bad about it because it's happening to everyone just the same.
D) an unobserved change in relative prices.

Accepted Answer

Money illusion is the tendency of people to consider nominal changes in income or prices without adjusting for inflation. This means that people with inflation-indexed wages might see an increase in prices and assume that their purchasing power has decreased, even if their real income hasn't changed.

Quiz 12: Inflation and the Quantity Theory of Money

Inflation tends to cause nominal wages to:

The primary reason we think of inflation as bad even when wages rise with it is that it:

High volatility in the inflation rate can result in:

When people suffer from money illusion,an increase in the money supply:

When the money supply and the demand for goods increase at the same time:

Money illusion is a condition in which people:

Suppose you are forced to take a pay cut of 5% when the economy is experiencing overall deflation of 5%.If in response to your pay cut you also reduce your consumption by 5%,then economists would say:

Inflation hurts the economy because:

Because of money illusion,inflation usually confuses:

Which of the following is an example of money illusion assuming that inflation is 5%?

Mistaking changes in nominal prices for changes in real prices is called a:

Money illusion occurs when people:

When an economy experiences volatile and unpredictable hyperinflation:

Which of the following is a problem with deflation?

When changes in nominal prices are confused with changes in real prices,people experience:

Money illusion occurs when people:

High and volatile inflation:

Jordan loaned Taylor $1,200 on March 15,2009.Taylor returned $1,260 on March 14,2010.Inflation was 2% over the 1-year period.What is the real interest rate that Taylor paid?

Which of the following is NOT a cost of inflation?

The concept of money illusion refers to: