Tutorial
Chapter 8
Inflation
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1. Inflation is defined as a(n)
a. increase in some prices.
b. increase in the price of a specific
commodity (or service).
c. sustained increase in the general price level.
d. sustained increase in the price of a specific
commodity (or service).
C. Not any increase in prices is considered
inflation. Some prices always increase because
of the workings of the price mechanism. Only
when the general level of prices increase over
time can we say that we have inflation.
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2. A sustained increase in the
general price level is called
a. deflation.
b. inflation.
c. disinflation.
d. hyperinflation.
B. A sustained decrease in the average price
level is called deflation. Disinflation is a
reduction in the rate of inflation.
Hyperinflation is a very high rate of inflation.
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3. Demand-pull inflation is induced by
a. inward shift in the aggregate demand curve.
b. inward shift in the aggregate supply curve.
c. outward shift in the aggregate supply and
demand curves.
d. outward shift in the aggregate demand
curve.
D. If you draw a downward sloping demand
curve and an upward sloping supply curve on
a piece of paper and then move the demand
curve to the right, you will see that prices will
increase. This is called demand-pull inflation.
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4. Cost-push inflation is typically induced by
a. inward shift in the demand curve.
b. inward shift in the aggregate supply
and demand curves.
c. outward shift in the demand curve.
d. inward shift in the supply curve.
D. If you draw a downward sloping demand
curve and an upward sloping supply curve
on a piece of paper and then move the supply
curve to the left, you will see that prices will
increase. This is called cost-push inflation.
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5. Cost-push inflation typically follows which of
the following patterns?
a. Aggregate supply decreases that ultimately
causes the price level to increase.
b. aggregate demand and aggregate supply
both decreases that ultimately causes the
price level to increase.
A. A factor that can cause a shift in supply is a
change in costs. As costs increases the supplier
cannot not afford to supply as much at every
price level as used to be the case. A leftward shift
of the aggregate supply curve will cause prices
to increase. This is called cost-push inflation.
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6. Demand-pull inflation typically follows which
of the following patterns? Aggregate demand
a. decreases that ultimately causes the price
level to increase.
b. increases that ultimately causes the price
level to increase.
c. and aggregate supply both increases that
ultimately causes the price level to
increase.
B. Because the downward sloping demand curve
is moving to the right along an upward
sloping supply curve, the increase in demand
will pull the general price level upward.
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7. The Consumer Price Index measures the cost of
a. all goods and services produced in the U.S. economy.
b. all goods produced in the U.S. economy.
c. a fixed market basket of consumer goods and
services produced in the U.S. economy.
C. The Consumer Price Index does not measure
the prices of all goods and services, but only a
particular basket of goods and services. As
times change and consumers buying habits
change, what goes into this basket changes.
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8. If the inflation rate is 14% per year, and your
nominal income increases by 13% per year,
your real income
a. declines slightly.
b. increases slightly.
c. increases substantially.
d. does not change.
A. With inflation increasing 1% more than
your income increases, your buying power,
or real income, goes down by 1%.
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9. A reduction in the rate on inflation is
known as
a. deflation.
b. disinflation.
c. inflation.
d. hyperinflation.
B. If inflation in year one is 6% and 5% in
year two, we experience disinflation. We still
have inflation in year two, but the inflation
rate is lower than in the previous year.
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10. If the deflation rate is 10 percent per year,
and your nominal wage rate increases by 11
percent per year, your real wage will
a. increase slightly.
b. increase substantially.
c. not change.
d. decrease slightly.
B. With a deflation rate of 10% (a fall in the
average price level) and a raise in pay of
11%, your real income would rise by 21%.
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11. The real rate of interest can best be expressed as the
a. nominal interest rate minus the real rate.
b. inflation rate minus the nominal interest rate.
c. nominal interest rate minus the inflation rate.
d. inflation rate minus the real interest rate.
C. For example, in the previous question,
your buying power went down by 1%
because 14% minus 13% equals -1%.
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12. If the annual inflation rate is 5% per
year, and the nominal interest rate is
6%, the real interest rate is
a. 1% per year.
b. 5% per year.
c. 6% per year.
d. 11% per year.
A. If you pay 6% to borrow money, but you repay
the loan in dollars that have decreased in value by
5%, the true cost to you for the loan is only 1%.
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13. Which of the following would best define
interest?
a. Dollar amount paid to lenders to forego
consumption.
b. Payment for abstinence.
c. Dollar amount paid by borrowers to
lenders to forego present consumption.
d. Dollar amount paid by lenders to
borrowers to forego present consumption.
C. People with money can either spend it or save it. In
order to forego present consumption, these people
need an incentive. The more interest they can earn on
their savings, the more incentive there is to save.
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14. Megan recently borrowed money to purchase
an automobile at a nominal interest rate of 8%
per year. If the inflation rate is 6% per year,
what is the real rate of interest on the loan?
a. 6% per year.
b. 8% per year.
c. 4% per year.
d. 2% per year.
D. By paying back an 8% loan with
dollars that have been deflated by 6%,
the true cost of the loan is only 2%.
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15. If future price changes were perfectly anticipated
by both borrowers and lenders, what would
happen to the real rate of interest in the future if
the price level changed? Real interest rate would
a. increase.
b. decrease.
c. decrease by the amount of the price increase.
d. not change.
D. With future price changes exactly anticipated by
both borrowers and lenders, interest rates would
increase at the same level as prices, and therefore
the real interest rate would not change.
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16. The misery index consists of the
a. inflation rate minus the unemployment rate.
b. unemployment rate minus the inflation rate.
c. unemployment rate plus the inflation rate.
d. unemployment rate minus the growth rate.
C. Because people are adversely affected by
inflation and unemployment, to be
affected by both results in real misery.
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17. The average rate of inflation during the
Great Depression of the 1930s was
a. very high.
b. moderate.
c. zero.
d. prices actually declined, we experienced
deflation not inflation.
D. The inflation rate prior to WWII was not
only low but during the 1930’s we actually
experienced substantial deflation because
of the Great Depression.
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18. If the CPI is 220 one year and 210 the
next, the annual rate of inflation is
measured by the CPI is approximately
a. -4.5%.
b. -2.3%.
c. 220%.
A. The rate of increase or decrease between two
numbers is the difference between the two numbers
divided by the original number. The difference
between 220 and 210 is -10. Negative 10 divided by
220 is equal to a negative .045, which is -4.5%. The
answer is a negative number because the CPI has
decreased in this example and not increased.
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19. If the CPI is 109 one year and 112 the
next, the annual rate of inflation is
measured by the CPI is approximately
a. 1.45%.
b. 2.75%.
c. 3.6%.
B. The difference between the two
numbers divided by the original
number is 3 / 109 = .0275 or 2.75%.
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20. Which categories are not included in
the core inflation rate published by
the Bureau of Labor Statistics?
a. Food and energy.
b. Luxury goods and automobiles.
c. Computers and televisions.
A. By excluding food and energy, the two
categories which increase in price the most,
the government can pay out less to Social
Security recipients whose payments
increase along with the core inflation rate.
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21. Which categories are not included in the core inflation
rate published by the Bureau of Labor Statistics?
a. Food and energy.
b. Luxury goods and automobiles.
c. Computers and televisions.
A. By excluding food and energy, the two
categories which increase in price the most,
the government can pay out less to Social
Security recipients whose payments
increase along with the core inflation rate.
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22. In terms of monetary and fiscal policies
which type of inflation is easiest to fight?
a. Demand pull.
b. Cost push.
c. Stagflation.
A. In terms of monetary and fiscal
policies we have more control
over demand than we do costs.
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23. What is the best remedy for solving the
problems of cost push type of inflation?
a. Decrease demand.
b. Lower costs in order to shift the
aggregate supply curve to the left.
c. Impose a wage price freeze.
A. By giving businesses an incentive to lower their
costs the aggregate supply curve can shift to the
left thus driving price down and quantity up.
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24. Who can cause deep rooted long
lasting inflation?
a. Businesses.
b. Consumers.
c. The federal government.
d. The Federal Reserve.
D. Only the Fed can increase the money supply
more than we increase goods and services.
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25. Which is the best way to have a healthy
growing economy with a low rate of
inflation over a long period of time?
a. Increase productivity.
b. Monetize the federal debt.
c. A greater centralization of power in the
hands of the federal government.
A. By increasing productivity we can have
lower prices, an increase in buying
power, and more employment.
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END
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