Question 1

Which of these statements is NOT correct?
A) If your nominal wages rise at a rate higher than the inflation rate, you have received a "real" pay raise.
B) If your nominal wages rise at exactly the rate of inflation, your purchasing power over time remains constant.
C) If your nominal wages rise at 4% while inflation rises at 5%, you have essentially received a "pay cut."
D) If deflation occurs, you will receive a "real" pay raise regardless of what happens to your nominal wage.

Accepted Answer

Deflation means the general level of prices is falling, so your purchasing power increases even if your nominal wages stay the same. However, this statement does not hold true for the other options. Option A is correct as an increase in nominal wages higher than the inflation rate means a real pay raise, option B is correct as there is no change in purchasing power over time, and option C is correct as inflation has reduced the purchasing power of your wages by more than the increase in nominal wages.

Question 2

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 for changes in real prices, meaning they are not taking inflation into account. This can lead to inappropriate decision-making and inaccurate perceptions of economic trends.

Question 3

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 unpredictable and unreliable. It also leads to a misallocation of resources and reduces economic growth. Option A is incorrect as high and volatile inflation causes prices to increase and deviate from the market price. Option B is incorrect as inflation reduces the purchasing power of money and income. Option C is incorrect as high inflation does not create a high supply of goods and services, but rather may lead to shortages and hoarding.

Question 4

Which one of the following is NOT a cost of inflation?
A) wasted resources associated with price confusion
B) higher tax burdens if tax brackets are not adjusted for inflation
C) wealth redistribution from private citizens to the government
D) an automatic decrease in real wages throughout the period of inflation.

Accepted Answer

Inflation does not necessarily result in an automatic decrease in real wages throughout the period of inflation. It can lead to a decrease in real wages if nominal wages do not increase as fast as the inflation rate, but it is not an automatic consequence. The other options are all costs of inflation.

Question 5

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

Accepted Answer

Declining wages are actually a consequence of inflation, rather than a cost. As prices rise, the purchasing power of wages decrease, leading to a decline in real wages. The other options listed are all costs of inflation: price confusion arises when inflation distorts relative prices; money illusion occurs when people mistake nominal wage or price changes for real ones; and inflation tax occurs when inflation reduces the value of money held by individuals and governments, effectively imposing a tax on their wealth.

Question 6

Episodes of hyperinflation are caused by:
A) severe recessions.
B) extreme economic booms.
C) extremely high rates of money growth.
D) moderately high rates of real GDP growth.

Accepted Answer

Episodes of hyperinflation are caused by extremely high rates of money growth. When the government or central bank prints large amounts of money to finance a budget deficit or to stimulate the economy, it can lead to an excessive supply of money relative to goods and services, causing prices to skyrocket.

Question 7

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 refers to the tendency of people to use nominal values rather than real values when making economic decisions, especially when it comes to inflation. Consumers with inflation-indexed wages who see a rise in prices might think that their purchasing power has been compromised even though their real wage remains constant. This is an example of money illusion.

Question 8

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 (prices in current dollars) for changes in real prices (prices adjusted for inflation) is called a money illusion. This can lead individuals and businesses to make misguided decisions based on inaccurate economic data.

Question 9

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 mistake changes in nominal prices for changes in real prices. For example, if people see their wages increase by 2%, but inflation has risen by 3%, they may believe that they have gained purchasing power when, in fact, they have lost it. This shows a confusion between nominal changes (in money terms) and real changes (adjusted for inflation).

Question 10

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

The answer of Inflation hurts the economy because:
A) it raises...

Question 11

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

Money illusion refers to the tendency of people to think of currency in nominal, rather than real, terms. In this scenario, the individual is exhibiting money illusion because they are only seeing the nominal pay cut of 5% and not accounting for the fact that overall deflation has also reduced their purchasing power. If they truly recognized the value of their real wage decreasing by 5%, they would not reduce their consumption by the same amount. Therefore, their decision is not truly rational as they are not taking into account the real value of their income.

Question 12

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

The answer of The primary reason we think of inflation...

Question 13

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 keep up with the rising cost of living.

Question 14

If people expect an inflation rate of 3% and later it turns out to be 5%, then the real rate of return will be:
A) less than the equilibrium rate.
B) greater than the equilibrium rate.
C) 3%.
D) 5%.

Accepted Answer

If people expect inflation rate of 3% and it turns out to be 5%, then the real rate of return (which is nominal rate minus inflation rate) will be lower than what people anticipated. This means that people overestimated the real rate of return, and hence it is less than the equilibrium rate. Therefore, option A is the best answer.

Question 15

Money illusion is:
A) the average number of times a dollar is spent on final goods and services in a year.
B) mistaking changes in nominal prices for changes in real prices.
C) a decrease in the average level of prices.
D) an increase in the average level of prices.

Accepted Answer

Money illusion refers to the mistaken belief that changes in nominal prices (the prices we see in currency) reflect real prices (the prices adjusted for inflation and purchasing power). It is a cognitive bias where people tend to focus on the nominal value of something rather than its real value.

Question 16

The "inflation parable" in the text refers to the fact that an unexpected change in the money supply affects:
A) real GDP only in the long run.
B) real GDP only in the short run.
C) real GDP in both the short run and the long run.
D) only inflation in the short run.

Accepted Answer

The "inflation parable" typically illustrates how an unexpected increase in the money supply can lead to short-term changes in real GDP due to price and wage stickiness, but in the long run, it primarily affects inflation rates without impacting real GDP.

Question 17

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 can cause a breakdown of financial intermediation because people lose confidence in the stability of the currency and financial institutions. As a result, they may withdraw their funds from banks and other financial institutions, and lending may decrease because lenders are less willing to lend in such an uncertain environment. This can further exacerbate the hyperinflation, creating a vicious cycle.

Question 18

How might changes in the money supply be non-neutral in the short run?
A) As the amount of money circulating in the economy changes before prices respond, the purchases of consumers change accordingly, which leads producers to change production levels.
B) When money supply changes in the short run, it will affect nominal, but not real, variables in the short run.
C) As money growth increases at a faster rate, it will cause real GDP to grow at an even faster rate.
D) If producers expect inflation to increase, they will increase supply in order to sell before the arrival of inflation.

Accepted Answer

In the short run, changes in the money supply can lead to changes in consumption and production before prices have a chance to fully adjust. This can cause non-neutrality in the short run as consumers and producers react to changes in the amount of money circulating in the economy. Option B is incorrect as changes in the money supply can affect both nominal and real variables in the short run. Option C is also incorrect as while an increase in the money supply can lead to an increase in real GDP, it does not necessarily mean it will be at a faster rate than the increase in the money supply. Option D is incorrect as producers cannot simply increase supply to sell before the arrival of inflation as supply is limited by factors such as production capacity, inputs, and technology.

Question 19

When the expected rate of inflation is higher than the actual rate of inflation, wealth is:
A) redistributed at random.
B) not redistributed at all.
C) redistributed from borrowers to lenders.
D) redistributed from lenders to borrowers.

Accepted Answer

When the expected rate of inflation is higher than the actual rate of inflation, lenders benefit because the real value of the money they are repaid is higher than anticipated. This results in a redistribution of wealth from borrowers to lenders, as borrowers end up paying back more in real terms than they had expected.

Question 20

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 can raise the real cost of debt repayment because the value of money increases over time, making it more expensive to pay back loans that were made at a higher value.

Quiz 12: Inflation and the Quantity Theory of Money

Which of these statements is NOT correct?

Money illusion occurs when people:

High and volatile inflation:

Which one of the following is NOT a cost of inflation?

Which of the following is NOT a cost of inflation?

Episodes of hyperinflation are caused by:

The concept of money illusion refers to:

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

Money illusion is a condition in which people:

Inflation hurts the economy because:

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:

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

Inflation tends to cause nominal wages to:

If people expect an inflation rate of 3% and later it turns out to be 5%, then the real rate of return will be:

Money illusion is:

The "inflation parable" in the text refers to the fact that an unexpected change in the money supply affects:

When an economy experiences volatile and unpredictable hyperinflation:

How might changes in the money supply be non-neutral in the short run?

When the expected rate of inflation is higher than the actual rate of inflation, wealth is:

Which of the following is a problem with deflation?