Question 1

Explain the notion of money illusion in specific detail.

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Question 2

What is the underlying concept behind future price level uncertainty?

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Question 3

Arguably there are three reasons why the consumer price index (CPI) overstates inflation. List the reasons and explain each one.

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Question 4

You own a store and have not raised prices recently-and now your store has more customers. Which statement is correct?
A) This can be troublesome because you face a "menu costs" problem because you must not have increased prices fast enough.
B) This can be troublesome because you face a price confusion problem: You don't know if the extra business means that you should open another store, or if the crowds are a result of inflation, which has caused all consumers to buy at a faster rate.
C) This can be troublesome because you face a future price uncertainty problem because you don't know how much to increase your prices now or in the future.
D) It can't be troublesome; it can only be good.
E) This can be troublesome because too many customers generate deflationary pressures for all businesses.

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Question 5

Using the table below, compute the consumer price index (CPI) in 2007 using 2006 as the base year. Show all your work.

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Question 6

The housing crisis has some roots in inflation because:
A) new houses were new goods and services and the consumer price index (CPI) didn't measure them.
B) builders confused inflation with an increase in demand and hence overbuilt-a price confusion problem.
C) there were menu costs associated with higher housing prices.
D) money illusion occurred when builders thought that real prices were rising.
E) money illusion occurred when housing buyers thought real wages were rising.

Accepted Answer

Builders may have mistakenly interpreted inflation as an increase in demand for housing, leading to an overbuilding of homes. This confusion of rising prices with increased demand could have contributed to the housing crisis.

Question 7

The distinction between price confusion problems and menu costs is that:
A) price confusion results from confusion between relative demand and inflationary pressures, whereas menu costs have to do with people confusing changes in nominal and real wages.
B) menu costs result from confusion between relative demand and inflationary pressures, whereas price confusion has to do with people confusing changes in nominal and real wages.
C) price confusion results from confusion between relative demand and inflationary pressures, whereas menu costs relate to producers changing prices, typically during inflationary periods.
D) menu costs occur during deflation, whereas price confusion problems occur during inflation.
E) menu costs only affect the food industry, whereas price confusion problems occur in high-tech industries.

Accepted Answer

Price confusion problems refer to consumers being confused by changes in prices due to inflation or changes in relative demand. On the other hand, menu costs are the costs incurred by producers of changing prices on their products due to inflation or other factors. Therefore, the best choice is C, as it correctly distinguishes between these two concepts. None of the other choices accurately describe the difference between price confusion problems and menu costs.

Question 8

Why would knowing the cost of living index be important in real life?
(Hint: Consider the following scenario. You get two job offers: one in San Francisco paying $80,000 per year and the other in Dallas paying $68,000 per year.)

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Question 9

In the 1970s, the government attempted to regulate prices to control inflation; this attempt was unsuccessful. The most likely reason was that:
A) it increased menu costs.
B) it created future price certainty.
C) it removed relative price signals for those items that had actual increases in demand that were not due to inflation.
D) it created money illusion.
E) the Watergate break-in destroyed Americans' faith in the government.

Accepted Answer

When the government regulated prices, it removed the relative price signals for those items that had actual increases in demand that were not due to inflation. This led to misallocation of resources as suppliers were unable to respond to market signals of increased demand. As a result, the attempt to control inflation was unsuccessful.

Question 10

It has been shown that increases in the money supply are directly related to the rate of inflation. If the previous statement is true, then:
A) nations that increase their money supply most rapidly will be the most prosperous.
B) hyperinflation will normally be associated with large increases in the money supply.
C) hyperinflation will normally be associated with large decreases in the money supply.
D) menu costs will rise when the money supply falls.
E) real wages rise whenever the money supply increases.

Accepted Answer

Hyperinflation is characterized by rapid increases in the general level of prices. These increases typically occur when the money supply is growing much faster than the economy's ability to produce goods and services. Therefore, hyperinflation is usually associated with large increases in the money supply.

Question 11

A price confusion problem is best described as:
A) the difficulty producers have in determining whether higher prices are due to increased demand or inflation.
B) the difficulty consumers have in determining whether real prices have risen in order to decide whether they should buy more or less.
C) the difficulty that producers have in determining whether a wage increase will lead to an increase in real costs.
D) the problem consumers have in determining whether relative prices have changed when all prices are increasing, albeit at different rates.
E) the problem both consumers and producers face in interpreting consumer price index (CPI) data from the Bureau of Labor Statistics (BLS).

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Question 12

Describe the methodology of finding the consumer price index (CPI).

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Question 13

In some nations the only currency is gold. Someone proposes the argument that if gold were the only currency, there could not be inflation. Would you agree or disagree with this statement? Explain

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Question 14

Your firm expands its output in a time when demand appears to be increasing. Demand for all goods is increasing because of inflation, and consumers want to buy all goods faster because their real purchasing power is falling due to inflation. This situation could indicate that:
A) your firm experienced future price uncertainty.
B) your firm experienced menu costs.
C) your firm experienced money illusion.
D) your firm experienced deflation.
E) your firm experienced a price confusion problem.

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The answer of Your firm expands its output in a...

Question 15

Arguably, the increases in housing prices in 2005-2006:
A) caused a menu cost problem for producers.
B) caused a price confusion problem for producers.
C) caused a money illusion problem for producers.
D) caused future price uncertainty for producers.
E) caused a money illusion problem for consumers.

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Question 16

Describe menu costs.

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Question 17

The website that provides official inflation statistics is:
A) www.econstats.com.
B) www.bls.gov.
C) www.bea.gov.
D) www.inflation.gov.
E) www.econometrics.com.

Accepted Answer

The Bureau of Labor Statistics (BLS) is responsible for calculating and reporting the official inflation statistics for the United States. Their website is www.bls.gov.

Question 18

Define inflation. Be specific. Be sure to address whether the prices of all goods are increasing, what is included in determining the basis for changes in the price level, and how the price level is measured.

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Question 19

According to the price confusion problem, if the price of a product increases, then:
A) the market demand has increased, and the firm's output should increase.
B) the market demand has increased, and the firm's output should decrease.
C) the price increase is due to inflation, and the firm's output should increase.
D) the price increase is due to inflation, and the firm's output should decrease.
E) prices as a whole fall, and the firm's output should increase.

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Question 20

Which of the following reflects a practical example of the price confusion problem?
A) Lines are short at the coffee shop you own because your resource prices are rising and your retail prices must be raised at the same rate; your customers are confused as to whether they should buy from your shop or not.
B) Long lines at the coffee shop you own prompt you to open a new coffee shop, but the second shop is unsuccessful because the first shop's success was just due to your prices being set too low (below market prices) because of inflation.
C) It is difficult for you to determine whether the long lines at your coffee shop are due to increased demand or because inflation has created "too many dollars chasing too few goods."
D) It is difficult for you to determine the right signal to send to your consumers through prices because the signal sent to you by the Bureau of Labor Statistics is easily misinterpreted.
E) Signals sent from consumers to producers are clear, but those from producers to consumers are confused.

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Quiz 8: The Price Level and Inflation

Explain the notion of money illusion in specific detail.

What is the underlying concept behind future price level uncertainty?

Arguably there are three reasons why the consumer price index (CPI) overstates inflation. List the reasons and explain each one.

You own a store and have not raised prices recently-and now your store has more customers. Which statement is correct?

Using the table below, compute the consumer price index (CPI) in 2007 using 2006 as the base year. Show all your work.

The housing crisis has some roots in inflation because:

The distinction between price confusion problems and menu costs is that:

Why would knowing the cost of living index be important in real life? (Hint: Consider the following scenario. You get two job offers: one in San Francisco paying $80,000 per year and the other in Dallas paying $68,000 per year.)

In the 1970s, the government attempted to regulate prices to control inflation; this attempt was unsuccessful. The most likely reason was that:

It has been shown that increases in the money supply are directly related to the rate of inflation. If the previous statement is true, then:

A price confusion problem is best described as:

Describe the methodology of finding the consumer price index (CPI).

In some nations the only currency is gold. Someone proposes the argument that if gold were the only currency, there could not be inflation. Would you agree or disagree with this statement? Explain

Your firm expands its output in a time when demand appears to be increasing. Demand for all goods is increasing because of inflation, and consumers want to buy all goods faster because their real purchasing power is falling due to inflation. This situation could indicate that:

Arguably, the increases in housing prices in 2005-2006:

Describe menu costs.

The website that provides official inflation statistics is:

Define inflation. Be specific. Be sure to address whether the prices of all goods are increasing, what is included in determining the basis for changes in the price level, and how the price level is measured.

According to the price confusion problem, if the price of a product increases, then:

Which of the following reflects a practical example of the price confusion problem?