Inflation
1. Inflation is defined as an increase in a. real wages of workers. b. real GDP. c. the average price level. d. all consumer products.
ANS a. Incorrect. Inflation concerns the average price level of products-not wages. b. Incorrect. Inflation concerns the average price level of products-not real GDP. c. Correct. Inflation is defined as an increase in the average price level. d. Incorrect. Since inflation is based on the average price level, some prices of products can decline during inflation.
2. Inflation is measured by an increase in a. homes, autos and basic resources. b. prices of all products in the economy. c. the consumer price index (CPI). d. none of the answers above is correct.
ANS a. Incorrect. Basic resources are not included in the CPI. b. Incorrect. The CPI is based on a market basket-not all products. c. Correct. Inflation is measured by an increase in the consumer price index (CPI). d. Incorrect. Answer c. is correct.
3. Which one of the following groups benefits from inflation? a. Borrowers. b. Savers. c. Landlords. d. Lenders.
ANS a. Correct. Borrowers can repay loans with cheaper dollars assuming wage increases equal or exceed the inflation rate. b. Incorrect. The real interest rate = nominal interest rate- inflation rate so an increase in inflation reduces the real interest rate on savings. c. Incorrect. Inflation reduces the nominal value of rental income. d. Incorrect. The real interest rate = nominal interest rate- inflation rate so an increase in inflation reduces the real interest rate on a loan.
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4. Price indexes like the CPI are calculated using a base year. The term base year refers to a. the first year that price data are available. b. any year in which inflation was higher than 5 percent. c. the most recent year in which the business cycle hit the trough. d. an arbitrarily chosen reference year.
ANS a. Incorrect. The base year is an arbitrarily chosen reference year. b. Incorrect. The base year is an arbitrarily chosen reference year. c. Incorrect. The base year is an arbitrarily chosen reference year. d. Correct. The base year is an arbitrarily chosen reference year.
5. If the consumer price index (CPI) in year 1 was 200 and the CPI in year 2 was 215, the rate of inflation was a. 215 percent. b. 15 percent. c. 5 percent. d. 7.5 percent. e. 8 percent.
ANS a. Incorrect. See calculation in answer d. b. Incorrect. See calculation in answer d. c. Incorrect. See calculation in answer d. d. Correct. (215 - 200)/200 = 15/200 = 7.5 percent.
6. Which of the following statements is true? a. Deflation is an increase in the general level of prices. b. The consumer price index (CPI) measures changes in the average prices of consumer goods and services. c. Disinflation is an increase in the rate of inflation. d. Real income is the actual number of dollars received over a period of time.
ANS a. Incorrect. Deflation is a decrease in the general level of prices. b. Correct. The consumer price index (CPI) measures changes in the average prices of consumer goods and services. c. Incorrect. Disinflation is a decrease in the rate of inflation. d. Incorrect. Nominal income is the actual number of dollars received.
7. Suppose the price of banana rises over time and consumers respond by buying fewer bananas. This situation contributes to which bias in the consumer price index? a. Substitution bias. b. Transportation bias. c. Quality bias. d. Indexing bias.
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ANS a. Correct. Substitution bias follows the law of demand, but the CPI assumes the quantity of an item in the market basket remains unchanged over time. b. Incorrect. This is a meaningless term. c. Incorrect. This refers to a failure of the CPI to account for changes in quality over time. d. Incorrect. This is a meaningless term.
8. Deflation means a decrease in a. the rate of inflation. b. the prices of all products in the economy. c. homes, autos, and basic resources. d. the general level of prices in the economy.
ANS a. Incorrect. Disinflation is decrease in rate of inflation. b. Incorrect. The CPI market basket does not include all products in the economy. c. Incorrect. Prices of basic resources are not included in the CPI, which measures price level changes. d. Correct. Deflation means a decrease in the general level of prices in the economy.
9. Real income in yearX is equal to a. yearX nominal income x 100.
yearX real GDP b. yearX nominal income x 100.
yearX real output c. yearX nominal income .
CPI/100 d. yearX nominal income x CPI.
ANS a. Incorrect. The correct formula is in answer c. b. Incorrect. The correct formula is in answer c. c. Correct. This is the correct formula. d. Incorrect. The correct formula is in answer c.
10. The real interest rate is defined as the a. actual interest rate. b. fixed-rate on consumer loans. c. nominal interest rate minus the inflation rate. d. expected interest rate minus the inflation rate.
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ANS a. Incorrect. The nominal or actual interest rate is not adjusted for inflation. b. Incorrect. A fixed rate is not adjusted for inflation. c. Correct. The real interest rate is defined as the nominal interest rate minus the inflation rate. d. Incorrect. An expected interest rate is not the actual nominal rate.
11. If the inflation rate exceeds the nominal rate of interest, a. the real interest rate is negative. b. lenders lose. c. savers lose. d. all of the answers are correct.
ANS a. Incorrect. All of the answers are correct. b. Incorrect. All of the answers are correct. c. Incorrect. All of the answers are correct. d. Correct. All of the answers are correct.
12. Suppose you place $10,000 in a retirement fund that earns a nominal interest rate of 8 percent. If you expect inflation to be 5 percent or lower, then you are expecting to earn a real interest rate of at least a. 1.6 percent. b. 3 percent. c. 4 percent. d. 5 percent.
ANS a. Incorrect. See calculation in answer b. b. Correct. Real interest rate = nominal interest rate - inflation rate = 8 percent - 5 percent
= 3 percent. c. Incorrect. See calculation in answer b. d. Incorrect. See calculation in answer b.
13. Which of the following can create demand-pull inflation? a. excessive aggregate spending b. sharply rising oil prices c. higher labor costs d. recessions and depressions
ANS a. Correct. Excessive aggregate spending shifts the aggregate demand curve rightward and cause inflation. b. Incorrect. This shifts the aggregate supply curve leftward. c. Incorrect. This shifts the aggregate supply curve leftward. d. Incorrect. In this case, the aggregate demand curve shifts leftward.
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14. Which of the following statements is true? a. Demand-pull inflation is caused by excess total spending. b. Cost-push inflation is caused by an increase in resource costs. c. If nominal interest rates remain the same and the inflation rate falls, real interest rates increase. d. If real interest rates are negative, lenders incur losses. e. All of the above answers are correct.
ANS a. Incorrect. All of the answers are correct. b. Incorrect. All of the answers are correct. c. Incorrect. All of the answers are correct. d. Incorrect. All of the answers are correct. e. Correct. All of the answers are correct.
15. Cost-push inflation is due to a. labor cost increases. b. energy cost increases. c. raw material cost increases. d. all of the answers are correct.
ANS a. Incorrect. All of the answers are correct. b. Incorrect. All of the answers are correct. c. Incorrect. All of the answers are correct. d. Correct. All of the answers are correct.
16. During periods of hyperinflation, which of the following is the most likely response of consumers? a. Save as much as possible. b. Spend money as fast as possible. c. Invest as much as possible. d. Lend money.
ANS a. Incorrect. Hyperinflation quickly erodes the value of savings. b. Correct. Consumers will spend now before prices sharply rise. c. Incorrect. Hyperinflation quickly erodes profits from investments. d. Incorrect. It is extremely risky for lenders to set an interest rate because of the rapidly changing inflation rate.
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17. The base year in the consumer price index (CPI) is a. given a value of zero. b. a year chosen as a reference for prices in all other years. c. always the first year in the current decade. d. established by law.
ANS a. Incorrect. The base year in the consumer price index (CPI) is a year chosen as a reference for prices in all other years. b. Correct. The base year in the consumer price index (CPI) is a year chosen as a reference for prices in all other years. c. Incorrect. The base year in the consumer price index (CPI) is a year chosen as a reference for prices in all other years. d. Incorrect. The base year in the consumer price index (CPI) is a year chosen as a reference for prices in all other years.
18. Deflation a. was prevalent during the oil shocks of the 1970s. b. will cause consumers’ purchasing power to shrink under current trends. c. has been persistent in the U.S. economy since the Great Depression. d. refers to none of the answers above.
ANS a. Incorrect. Inflation was prevalent during this period of time. b. Incorrect. Deflation causes purchasing power to increase. c. Incorrect. Deflation has occurred infrequently since the Great Depression. d. Correct. Deflation is a decrease in the average price level of goods.
19. As the price of gasoline rose during the 1970s, consumers cut back on their use of gasoline relative to other consumer goods. This situation contributed to which bias in the consumer price index? a. substitution bias b. tqansportation bias c. Quality bias d. indexing bias
ANS a. Correct. Following the law of demand, if the price of a good rises, then the quantity demanded falls because people buy substitutes. However, the CPI assumes a fixed market basket, which overstates the quantity demanded. b. Incorrect. This is a meaningless term. c. Incorrect. This refers to the difficulty of adjusting for changes in quality over time and not price changes. d. Incorrect. This is a meaningless term.
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20. If the rate of inflation in a given time period turns out to be lower than lenders and borrowers anticipated, then the effect will be a a. redistribution of wealth from borrowers to lenders. b. redistribution of wealth from lenders to borrowers. c. net loss in purchasing power for lenders relative to borrowers. d. net gain in purchasing power for borrowers relative to lenders.
ANS a. Correct. The real rate of interest equals the nominal rate of interest minus the inflation rate. Lower inflation increases the real rate of interest, which is profit for the lenders. b. Incorrect. The real rate of interest equals the nominal rate of interest minus the inflation rate. Lower inflation increases the real rate of interest, which is profit for the lenders. c. Incorrect. The real rate of interest equals the nominal rate of interest minus the inflation rate. Lower inflation increases the real rate of interest, which is profit for the lenders. d. Incorrect. The real rate of interest equals the nominal rate of interest minus the inflation rate. Lower inflation increases the real rate of interest, which is profit for the
. lenders.
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