Question 1

Describe how a lender can lose during inflation if the inflation is unanticipated and the loan is a fixed-interest-rate loan.How would a variable-interest-rate loan (one that adjusts over the contract period)eliminate these losses?

Accepted Answer

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Question 2

When the actual inflation rate turns out to be greater than the expected inflation rate,who gains - the borrower or the lender - and who loses? Explain why.

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Question 3

The costs to firms of changing prices are called menu costs.

Accepted Answer

This statement is true. The term "menu costs" refers to the expenses that firms incur in order to change their prices, such as the cost of printing new price tags, updating websites and advertising materials, and retraining staff. These costs can discourage firms from adjusting their prices frequently, which can have implications for the overall health of the economy.

Question 4

Explain whether you agree or disagree with the following statement: "The reason that inflation is bad is because it increases the cost of living-the costs of goods and services we buy-without increasing income in general."

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Question 5

The problem with inflation is that as prices rise,consumers can no longer afford to buy as many goods and services.

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Question 6

There are no costs to inflation if it is fully anticipated.

Accepted Answer

Even if inflation is fully anticipated, there are still costs such as menu costs (the costs of changing prices), shoe leather costs (the costs associated with more frequent transactions or withdrawals of money), and the distortions it can cause in taxation and savings.

Question 7

If inflation is anticipated,some effects of inflation on the redistribution of income can be avoided.

Accepted Answer

If inflation is anticipated, people can adjust their behavior and take steps to protect their assets and income, such as investing in inflation-resistant assets or negotiating for wage increases. This can mitigate the negative effects of inflation on the redistribution of income. However, if inflation is unexpected, it can lead to greater income inequality as those on fixed incomes or with limited assets are hit the hardest.

Question 8

If inflation is unanticipated,no redistribution of income can occur.

Accepted Answer

Unanticipated inflation can cause a redistribution of income, as it affects different groups in the economy differently. For example, lenders may lose out if inflation reduces the value of the money they receive in repayment, while borrowers benefit from being able to repay loans with less valuable currency. Similarly, if wages do not keep pace with inflation, workers may see their purchasing power decrease, while businesses that are able to raise their prices may see higher profits.

Question 9

Describe how inflation can be costly even if it is anticipated.

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Question 10

Explain why you would rather be a borrower during a period of unexpected rising inflation,and a lender during a period of unexpected declining inflation.

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Question 11

The deflation of the 1930s impacted the U.S.economy because it led some consumers to ________ and because it ________.

Accepted Answer

The deflation of the 1930s caused consumers to postpone purchases as they waited for prices to fall even lower, leading to reduced demand and a slowdown in economic activity. Additionally, deflation increased the burden on borrowers as the value of their debts remained the same, but their income and assets decreased in value.

Question 12

Inflation redistributes income to a greater extent when the inflation is unanticipated compared to when the inflation is anticipated.

Accepted Answer

When inflation is unanticipated, people are not able to adjust their behavior accordingly and may see a decline in their purchasing power. This can lead to a more significant redistribution of income as those who are better able to protect themselves from inflation, such as those with more assets or higher wages, may be less affected. In contrast, when inflation is anticipated, people can adjust their behavior by increasing their savings or investing in assets that are less affected by inflation, which can reduce the impact on their purchasing power and result in a less significant redistribution of income.

Quiz 13: Unemployment and Inflation