Question 1

If the nominal interest rate was 12 percent and the inflation rate was 10 percent in 1980, while the nominal interest rate was 7 percent and the inflation rate was 2 percent in 2001, then

Accepted Answer

The real interest rate can be roughly calculated as the nominal interest rate minus the inflation rate. For 1980, the real interest rate is 2 percent (12% - 10%), and for 2001, it is 5 percent (7% - 2%). Therefore, real rates were higher in 2001.

Question 2

Americans viewed the 12 percent mortgage interest rates of the 1980s as exorbitantly high while they considered the 7 percent mortgage interest rates of the late 1990s as reasonable.This represents a confusion of

Accepted Answer

The confusion in Americans' perceptions of mortgage interest rates in the 1980s versus the late 1990s reflects a confusion between real and nominal interest rates. Real interest rates account for inflation, while nominal interest rates do not, and as inflation rates change over time, so too does our perception of what constitutes a high or low interest rate. The 12 percent mortgage interest rates of the 1980s were high both in nominal and real terms, while the 7 percent rates of the late 1990s were low in nominal terms but still relatively high in real terms due to lower inflation rates.

Question 3

When a lender underestimates the rate of inflation,

Accepted Answer

When a lender underestimates the rate of inflation, the real value of the money repaid by the borrower is less than anticipated, effectively redistributing purchasing power from the lender to the borrower.

Question 4

After a particular loan has been paid off, neither the borrower nor the lender has lost purchasing power.Therefore, it must be true that actual inflation was

Accepted Answer

When a loan is paid off, both the borrower and the lender regain their purchasing power without any loss. This means that the inflation rate must have been equal to the expected inflation rate projected when the loan was initiated. Therefore, the correct answer is B, which means actual inflation was equal to expected inflation.

Question 5

If a borrower arbitrarily gains purchasing power as the result of a particular loan agreement, then

Accepted Answer

If a borrower gains purchasing power as the result of a loan, it means that they are able to purchase more goods and services than they would have been able to without the loan. This can happen when the inflation rate is higher than the interest rate on the loan, causing the borrower's loan payments to be worth less in real terms over time. Therefore, actual inflation was greater than expected inflation.

Question 6

If expected inflation is 12 percent and the publicly regulated electric utility company is legally limited to a 10 percent rate of return, then we should expect

Accepted Answer

If the publicly regulated electric utility company is limited to a 10% rate of return but expected inflation is 12%, then the company will not be able to make enough profit to cover the higher costs of goods and services. This will make it difficult for the company to maintain its current level of service, and it may lead to power shortages in the future. The company may also be forced to cut costs, which could result in lower quality service or reduced investment in expansion or upgrading of its facilities.

Question 7

Rachel agrees to lend Phoebe $100 for six months and charges her interest of 2 percent.At the end of the six-month period, prices have risen by 4 percent.

Accepted Answer

Phoebe borrowed $100 from Rachel at an interest rate of 2 percent for six months, so she owes Rachel $102 after six months. However, prices have risen by 4 percent during that time, which means that Phoebe's $102 is now worth only $98 in terms of purchasing power. This means that purchasing power has been redistributed from Phoebe to Rachel, as Rachel's $102 now has greater purchasing power than Phoebe's $98.

Question 8

If you purchased shares of common stock in 1990 for $1,000 and sold them for $2,000 in 2001 you would be liable for taxes on

Accepted Answer

The taxable gain is calculated by subtracting the cost basis (original purchase price) from the selling price, which in this case is $2,000 - $1,000 = $1,000. The rate of inflation is not relevant for this calculation.

Question 9

When nominal interest rates are held below inflation rates, then households will have an incentive to

Accepted Answer

When nominal interest rates are below inflation rates, the real interest rate (adjusted for inflation) becomes negative. This means that individuals would earn a negative return on their savings, which would make saving less attractive. On the other hand, borrowing becomes cheaper, and borrowing to consume becomes more attractive. Therefore, households would have an incentive to consume rather than to save.

Question 10

If an investor had a $25,000 long-term capital gain on a $100,000 investment from 1984 to 2010, her real rate of return was most likely

Accepted Answer

The answer of If an investor had a $25,000 long-term...

Question 11

The federal government collects taxes on

Accepted Answer

The federal government collects taxes on nominal capital gains, which are the gains realized from the sale of an asset that exceed its purchase price. Real capital gains, which account for inflation, are not subject to taxation. Real and nominal capital losses can be used to offset capital gains and reduce one's tax liability.

Question 12

If actual inflation is less than the expected rate of inflation, then probably

Accepted Answer

If actual inflation is less than the expected rate of inflation, it means that the lender expected to receive a higher interest rate on the loan to compensate for the expected inflation. However, since the actual inflation rate is lower, the borrower ends up paying a lower interest rate than expected, giving them an advantage. On the other hand, the lender is receiving a lower interest rate than expected, leading to a loss. Therefore, the lender gains at the expense of the borrower.

Question 13

Inflation affects borrowers and lenders differently.After signing a contract with a fixed nominal interest rate, it can be expected that

Accepted Answer

Inflation leads to a decrease in the purchasing power of money over time. Borrowers who have signed a fixed nominal interest rate contract will benefit from inflation as they will be paying back a loan with money that has less purchasing power. On the other hand, lenders will lose out as the money repaid to them will have less purchasing power than the money they originally lent. Therefore, borrowers will hope for rising prices (inflation) while lenders will hope for falling prices (deflation).

Question 14

Some economists believe that technological progress could be increased if the federal government

Accepted Answer

The answer of Some economists believe that technological progress could...

Question 15

Over the past few decades, nominal interest rates have been higher than real rates of interest.This means that

Accepted Answer

Nominal interest rates are the actual rates at which borrowers lend and lenders borrow money. Real interest rates, on the other hand, take inflation into account and adjust for it. When nominal interest rates are higher than real rates, it indicates that inflation is present and lenders have factored it in. This means that borrowers must pay a higher rate to account for inflation, and lenders receive a higher rate to make up for the loss in purchasing power due to inflation.

Question 16

If inflation is expected by both borrowers and lenders, then we would expect

Accepted Answer

If both borrowers and lenders expect inflation, lenders will demand higher nominal interest rates to account for the expected loss of purchasing power. However, borrowers will also be willing to pay higher nominal rates since they know that the money they receive today will be worth less in the future due to expected inflation. As a result, nominal interest rates will be higher than real interest rates, which account for inflation. Therefore, real rates will be lower than nominal rates of interest.

Question 17

Sharon buys some common stock in 1990 for $10,000 and sells it in 2000 for $15,000.During the same period, prices have risen by 75 percent.The net result of Sharon's stock purchases is that she will

Accepted Answer

Sharon's nominal gain is $5,000 ($15,000 - $10,000). However, due to a 75% inflation rate, the real value of her initial investment has decreased. The real value of her initial $10,000 investment would need to be $17,500 by 2000 to maintain its purchasing power ($10,000 * 1.75). Since she sold for $15,000, she actually lost purchasing power. Despite this loss in real terms, she would still be liable for taxes on the nominal gain.

Question 18

The difference between the purchase price of a financial asset and the sale price of the asset is called a(n)

Accepted Answer

Capital gain is the correct term for the difference between the purchase price and the sale price of a financial asset.

Question 19

If an investor had a $100,000 long-term capital gain on a $100,000 investment from 1984 to 2010, her real rate of return was most likely

Accepted Answer

The answer of If an investor had a $100,000 long-term...

Question 20

Economists feel that taxing nominal capital gains imposes costs on the economy due to

Accepted Answer

Taxing nominal capital gains reduces the after-tax return on investment, which in turn reduces the incentive to save and invest. Reduced investment can lead to a decrease in productivity and economic growth, and therefore, imposing costs on the economy.

Quiz 23: The Goals of Macroeconomic Policy