ECON 214 HW17 Money, Growth, and Inflation Assignment solutions complete answers

ECON 214 HW17 Money, Growth, and Inflation Assignment solutions complete answers

 

1. The level of prices and the value of money

Suppose the price level reflects the number of dollars needed to buy a basket of goods containing one can of seltzer, one bag of pretzels, and one shuttle ride. In year one, the basket costs $9.00.

In year two, the price of the same basket is $8.00. From year one to year two, there is    at an annual rate of    .

In year one, $72.00 will buy    baskets, and in year two, $72.00 will buy    baskets.

This example illustrates that, as the price level falls, the value of money    .

 

Suppose the price level reflects the number of dollars needed to buy a basket of goods containing one energy drink, one egg sandwich, and one bike rental. In year one, the basket costs $14.00.

In year two, the price of the same basket is $15.00. From year one to year two, there is    at an annual rate of    .

In year one, $28.00 will buy    baskets, and in year two, $28.00 will buy    baskets.

This example illustrates that, as the price level rises, the value of money    .

 

Suppose the price level reflects the number of dollars needed to buy a basket of goods containing one latte, one scone, and one bus trip. In year one, the basket costs $13.00.

In year two, the price of the same basket is $12.00. From year one to year two, there is    at an annual rate of    .

In year one, $65.00 will buy    baskets, and in year two, $65.00 will buy    baskets.

This example illustrates that, as the price level falls, the value of money    .

 

2. Money supply, money demand, and adjustment to monetary equilibrium

The following table gives the quantity of money demanded at various price levels (P�), the money demand schedule.

In the following table, fill in the column labeled Value of Money.

Price Level (P)
Value of Money (1/P)
Quantity of Money Demanded
(Billions of dollars)
0.80
    
2.0
1.00
    
2.5
1.33
    
4.0
2.00
    
8.0
Now consider the relationship between the quantity of money that people demand and the price level. The lower the price level, the    money required to complete transactions, and the    money people will want to hold in the form of currency or demand deposits.

Assume that the Federal Reserve initially fixes the quantity of money supplied at $4 billion.

Use the orange line (square symbol) to plot the initial money supply (MS1MS1) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve.

 

According to your graph, the equilibrium value of money is    , therefore the equilibrium price level is    .

Now, suppose that the Fed reduces the money supply from the initial level of $4 billion to $2.5 billion.

In order to reduce the money supply, the Fed can use open market operations to    the public.

Use the purple line (diamond symbol) to plot the new money supply (MS2MS2).

Immediately after the Fed changes the money supply from its initial equilibrium level, the quantity of money supplied is     than the quantity of money demanded at the initial equilibrium. This contraction in the money supply will    people's demand for goods and services. In the long run, since the economy's ability to produce goods and services has not changed, the prices of goods and services will    and the value of money will    .

 

The following table gives the quantity of money demanded at various price levels (P�), the money demand schedule.

In the following table, fill in the column labeled Value of Money.

Price Level (P)
Value of Money (1/P)
Quantity of Money Demanded
(Billions of dollars)
1.00
    
1.5
1.33
    
2.0
2.00
    
3.5
4.00
    
7.0
Now consider the relationship between the quantity of money that people demand and the price level. The higher the price level, the    money required to complete transactions, and the    money people will want to hold in the form of currency or demand deposits.

Assume that the Federal Reserve initially fixes the quantity of money supplied at $3.5 billion.

Use the orange line (square symbol) to plot the initial money supply (MS1MS1) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve.

 

According to your graph, the equilibrium value of money is    , therefore the equilibrium price level is    .

Now, suppose that the Fed increases the money supply from the initial level of $3.5 billion to $7 billion.

In order to increase the money supply, the Fed can use open market operations to    the public.

Use the purple line (diamond symbol) to plot the new money supply (MS2MS2).

Immediately after the Fed changes the money supply from its initial equilibrium level, the quantity of money supplied is     than the quantity of money demanded at the initial equilibrium. This expansion in the money supply will    people's demand for goods and services. In the long run, since the economy's ability to produce goods and services has not changed, the prices of goods and services will    and the value of money will    .

 

The following table gives the quantity of money demanded at various price levels (P�), the money demand schedule.

In the following table, fill in the column labeled Value of Money.

Price Level (P)
Value of Money (1/P)
Quantity of Money Demanded
(Billions of dollars)
1.00
    
2.0
1.33
    
2.5
2.00
    
4.0
4.00
    
8.0
Now consider the relationship between the quantity of money that people demand and the price level. The lower the price level, the    money required to complete transactions, and the    money people will want to hold in the form of currency or demand deposits.

Assume that the Federal Reserve initially fixes the quantity of money supplied at $2.5 billion.

Use the orange line (square symbol) to plot the initial money supply (MS1MS1) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve.

 

According to your graph, the equilibrium value of money is    , therefore the equilibrium price level is    .

Now, suppose that the Fed increases the money supply from the initial level of $2.5 billion to $4 billion.

In order to increase the money supply, the Fed can use open market operations to    the public.

Use the purple line (diamond symbol) to plot the new money supply (MS2MS2).

Immediately after the Fed changes the money supply from its initial equilibrium level, the quantity of money supplied is     than the quantity of money demanded at the initial equilibrium. This expansion in the money supply will    people's demand for goods and services. In the long run, since the economy's ability to produce goods and services has not changed, the prices of goods and services will    and the value of money will    .

 

3. The classical dichotomy and the neutrality of money

The classical dichotomy is the separation of real and nominal variables. The following questions test your understanding of this distinction.

Yesmina divides all of her income between spending on puzzle books and Americanos. In 2016, she earned an hourly wage of $28.00, the price of a puzzle book was $7.00, and the price of a Americano was $4.00.

Which of the following give the real value of a variable? Check all that apply.

 The price of a puzzle book is 1.75 Americanos in 2016.

 The price of a puzzle book is $7.00 in 2016.

 Yesmina's wage is $28.00 per hour in 2016.

Which of the following give the nominal value of a variable? Check all that apply.

 The price of a Americano is $4.00 in 2016.

 The price of a Americano is 0.57 puzzle books in 2016.

 Yesmina's wage is 4 puzzle books per hour in 2016.

Suppose that the Fed sharply increases the money supply between 2016 and 2021. In 2021, Yesmina's wage has risen to $56.00 per hour. The price of a puzzle book is $14.00 and the price of a Americano is $8.00.

In 2021, the relative price of a puzzle book is    .

Between 2016 and 2021, the nominal value of Yesmina's wage    , and the real value of her wage    .

Monetary neutrality is the proposition that a change in the money supply    nominal variables and    real variables.

 

The classical dichotomy is the separation of real and nominal variables. The following questions test your understanding of this distinction.

Taia divides all of her income between spending on paperbacks and macchiatos. In 2017, she earned an hourly wage of $28.00, the price of a paperback was $7.00, and the price of a macchiato was $4.00.

Which of the following give the real value of a variable? Check all that apply.

 The price of a paperback is $7.00 in 2017.

 The price of a paperback is 1.75 macchiatos in 2017.

 Taia's wage is 7 macchiatos per hour in 2017.

Which of the following give the nominal value of a variable? Check all that apply.

 The price of a macchiato is 0.57 paperbacks in 2017.

 The price of a macchiato is $4.00 in 2017.

 Taia's wage is $28.00 per hour in 2017.

Suppose that the Fed sharply increases the money supply between 2017 and 2022. In 2022, Taia's wage has risen to $56.00 per hour. The price of a paperback is $14.00 and the price of a macchiato is $8.00.

In 2022, the relative price of a paperback is    .

Between 2017 and 2022, the nominal value of Taia's wage    , and the real value of her wage    .

Monetary neutrality is the proposition that a change in the money supply    nominal variables and    real variables.

 

The classical dichotomy is the separation of real and nominal variables. The following questions test your understanding of this distinction.

Tanisha divides all of her income between spending on digital movie rentals and lattes. In 2015, she earned an hourly wage of $28.00, the price of a digital movie rental was $7.00, and the price of a latte was $4.00.

Which of the following give the real value of a variable? Check all that apply.

 Tanisha's wage is $28.00 per hour in 2015.

 Tanisha's wage is 7 lattes per hour in 2015.

 The price of a digital movie rental is 1.75 lattes in 2015.

Which of the following give the nominal value of a variable? Check all that apply.

 Tanisha's wage is 4 digital movie rentals per hour in 2015.

 Tanisha's wage is $28.00 per hour in 2015.

 The price of a latte is $4.00 in 2015.

Suppose that the Fed sharply increases the money supply between 2015 and 2020. In 2020, Tanisha's wage has risen to $56.00 per hour. The price of a digital movie rental is $14.00 and the price of a latte is $8.00.

In 2020, the relative price of a digital movie rental is    .

Between 2015 and 2020, the nominal value of Tanisha's wage    , and the real value of her wage    .

Monetary neutrality is the proposition that a change in the money supply    nominal variables and    real variables.

 

4. Velocity and the quantity equation

Consider a simple economy that produces only streaming devices. The following table contains information on the economy's money supply, velocity of money, price level, and output. For example, in 2020, the money supply was $400, the price of a streaming device was $7.50, and the economy produced 800 streaming devices.

Fill in the missing values in the following table, selecting the answers closest to the values you calculate.

Year
Quantity of Money
Velocity of Money
Price Level
Quantity of Output
Nominal GDP
(Dollars)
(Dollars)
(Streaming devices)
(Dollars)
2020
400
 

 
7.50
800
    
2021
408
15
    
800
    
The money supply grew at a rate of    from 2020 to 2021. Since streaming device output did not change from 2020 to 2021 and the velocity of money    , the change in the money supply was reflected    in changes in the price level. The inflation rate from 2020 to 2021 was    .

 

Consider a simple economy that produces only jean jackets. The following table contains information on the economy's money supply, velocity of money, price level, and output. For example, in 2021, the money supply was $400, the price of a jean jacket was $10.00, and the economy produced 800 jean jackets.

Fill in the missing values in the following table, selecting the answers closest to the values you calculate.

Year
Quantity of Money
Velocity of Money
Price Level
Quantity of Output
Nominal GDP
(Dollars)
(Dollars)
(Jean jackets)
(Dollars)
2021
400
 

 
10.00
800
    
2022
420
20
    
800
    
The money supply grew at a rate of    from 2021 to 2022. Since jean jacket output did not change from 2021 to 2022 and the velocity of money    , the change in the money supply was reflected    in changes in the price level. The inflation rate from 2021 to 2022 was    .

 

Consider a simple economy that produces only air fryers. The following table contains information on the economy's money supply, velocity of money, price level, and output. For example, in 2019, the money supply was $400, the price of a air fryer was $5.00, and the economy produced 800 air fryers.

Fill in the missing values in the following table, selecting the answers closest to the values you calculate.

Year
Quantity of Money
Velocity of Money
Price Level
Quantity of Output
Nominal GDP
(Dollars)
(Dollars)
(Air fryers)
(Dollars)
2019
400
 

 
5.00
800
    
2020
412
10
    
800
    
The money supply grew at a rate of    from 2019 to 2020. Since air fryer output did not change from 2019 to 2020 and the velocity of money    , the change in the money supply was reflected    in changes in the price level. The inflation rate from 2019 to 2020 was    .

 

5. Using money creation to pay for government spending

Consider Katmai, a hypothetical country that produces only salmon burgers. In 2021, a salmon burger is priced at $8.00.

Complete the first row of the table with the quantity of salmon burgers that can be bought with $900.

Hint: In this problem, assume it is not possible to buy a fraction of a salmon burger, and always round down to the nearest whole salmon burger. For example, if your calculations result in 1.5 salmon burgers, the answer should be 1 salmon burger.

Year
Price of a Salmon burger
Salmon burgers Bought with $900
(Dollars)
(Quantity)
2021
8.00
 

 
2022
 
 
Suppose the government of Katmai cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 50% by 2022.

Assuming monetary neutrality holds, complete the second row of the table with the new price of a salmon burger and the new quantity of salmon burgers that can be bought with $900 in 2022.

The impact of the government's decision to raise revenue by printing money on the value of money is known as the    .

 

Consider Arcadia, a hypothetical country that produces only lobster rolls. In 2019, a lobster roll is priced at $6.00.

Complete the first row of the table with the quantity of lobster rolls that can be bought with $1,100.

Hint: In this problem, assume it is not possible to buy a fraction of a lobster roll, and always round down to the nearest whole lobster roll. For example, if your calculations result in 1.5 lobster rolls, the answer should be 1 lobster roll.

Year
Price of a Lobster roll
Lobster rolls Bought with $1,100
(Dollars)
(Quantity)
2019
6.00
 

 
2020
 
 
Suppose the government of Arcadia cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 30% by 2020.

Assuming monetary neutrality holds, complete the second row of the table with the new price of a lobster roll and the new quantity of lobster rolls that can be bought with $1,100 in 2020.

The impact of the government's decision to raise revenue by printing money on the value of money is known as the    .

 

Consider Kobuk, a hypothetical country that produces only crab cakes. In 2020, a crab cake is priced at $7.00.

Complete the first row of the table with the quantity of crab cakes that can be bought with $500.

Hint: In this problem, assume it is not possible to buy a fraction of a crab cake, and always round down to the nearest whole crab cake. For example, if your calculations result in 1.5 crab cakes, the answer should be 1 crab cake.

Year
Price of a Crab cake
Crab cakes Bought with $500
(Dollars)
(Quantity)
2020
7.00
 

 
2021
 
 
Suppose the government of Kobuk cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 40% by 2021.

Assuming monetary neutrality holds, complete the second row of the table with the new price of a crab cake and the new quantity of crab cakes that can be bought with $500 in 2021.

The impact of the government's decision to raise revenue by printing money on the value of money is known as the    .

 

6. The Fisher effect and the cost of unexpected inflation

Suppose the nominal interest rate on savings accounts is 12% per year, and both actual and expected inflation are equal to 4%.

Complete the first row of the table by filling in the expected real interest rate and the actual real interest rate before any change in the money supply.

Time Period
Nominal Interest Rate
Expected Inflation
Actual Inflation
Expected Real Interest Rate
Actual Real Interest Rate
(Percent)
(Percent)
(Percent)
(Percent)
(Percent)
Before increase in MS
12
4
4
 
 

 
Immediately after increase in MS
12
4
 10
 

 
 
Now suppose the Fed unexpectedly increases the growth rate of the money supply, causing the inflation rate to rise unexpectedly from 4% to 10% per year.

Complete the second row of the table by filling in the expected and actual real interest rates on savings accounts immediately after the increase in the money supply (MS).

The unanticipated change in inflation arbitrarily harms    .

Now consider the long-run impact of the change in money growth and inflation. According to the Fisher effect, as expectations adjust to the new, higher inflation rate, the nominal interest rate will    to

 

per year.

 

Suppose the nominal interest rate on car loans is 11% per year, and both actual and expected inflation are equal to 3%.

Complete the first row of the table by filling in the expected real interest rate and the actual real interest rate before any change in the money supply.

Time Period
Nominal Interest Rate
Expected Inflation
Actual Inflation
Expected Real Interest Rate
Actual Real Interest Rate
(Percent)
(Percent)
(Percent)
(Percent)
(Percent)
Before increase in MS
11
3
3
 
 

 
Immediately after increase in MS
11
3
 8
 

 
 
Now suppose the Fed unexpectedly increases the growth rate of the money supply, causing the inflation rate to rise unexpectedly from 3% to 8% per year.

Complete the second row of the table by filling in the expected and actual real interest rates on car loans immediately after the increase in the money supply (MS).

The unanticipated change in inflation arbitrarily harms    .

Now consider the long-run impact of the change in money growth and inflation. According to the Fisher effect, as expectations adjust to the new, higher inflation rate, the nominal interest rate will    to

 

per year.

 

Suppose the nominal interest rate on car loans is 9% per year, and both actual and expected inflation are equal to 5%.

Complete the first row of the table by filling in the expected real interest rate and the actual real interest rate before any change in the money supply.

Time Period
Nominal Interest Rate
Expected Inflation
Actual Inflation
Expected Real Interest Rate
Actual Real Interest Rate
(Percent)
(Percent)
(Percent)
(Percent)
(Percent)
Before increase in MS
9
5
5
 
 

 
Immediately after increase in MS
9
5
 6
 

 
 
Now suppose the Fed unexpectedly increases the growth rate of the money supply, causing the inflation rate to rise unexpectedly from 5% to 6% per year.

Complete the second row of the table by filling in the expected and actual real interest rates on car loans immediately after the increase in the money supply (MS).

The unanticipated change in inflation arbitrarily harms    .

Now consider the long-run impact of the change in money growth and inflation. According to the Fisher effect, as expectations adjust to the new, higher inflation rate, the nominal interest rate will    to

 

per year.

 

7. Identifying costs of inflation

Meagan owns and operates a store in a country experiencing a high rate of inflation. Each day, some of her employees spend time tracking changes in the overall price level and changing the price tags within the store and the price lists on the store's website. This is an example of the    of inflation.

 

Victor manages a grocery store in a country experiencing a high rate of inflation. He is paid in cash twice per month. On payday, he immediately goes out and buys all the goods he will need over the next two weeks in order to prevent the money in his wallet from losing value. What he can't spend, he converts into a more stable foreign currency for a steep fee. This is an example of the    of inflation.

 

Rod manages a grocery store in a country experiencing a high rate of inflation. To keep up with inflation, he spends a lot of time every day updating the prices, printing new price tags, and sending out newspaper inserts advertising the new prices. His employees regularly deal with customer annoyance over the frequent price changes. This is an example of the    of inflation.

 

8. Inflation-induced tax distortions

Pat receives a portion of his income from his holdings of interest-bearing U.S. government bonds. The bonds offer a real interest rate of 3% per year. The nominal interest rate on the bonds adjusts automatically to account for the inflation rate.

The government taxes nominal interest income at a rate of 20%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario.

Given the real interest rate of 3% per year, find the nominal interest rate on Pat's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario.

Inflation Rate
Real Interest Rate
Nominal Interest Rate
After-Tax Nominal Interest Rate
After-Tax Real Interest Rate
(Percent)
(Percent)
(Percent)
(Percent)
(Percent)
2.5
3.0
 
 
 

 
6.5
3.0
 
 
 

 
Compared with lower inflation rates, a higher inflation rate will    the after-tax real interest rate when the government taxes nominal interest income. This tends to    saving, thereby    the quantity of investment in the economy and    the economy's long-run growth rate.

 

Kevin receives a portion of his income from his holdings of interest-bearing U.S. government bonds. The bonds offer a real interest rate of 4.5% per year. The nominal interest rate on the bonds adjusts automatically to account for the inflation rate.

The government taxes nominal interest income at a rate of 20%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario.

Given the real interest rate of 4.5% per year, find the nominal interest rate on Kevin's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario.

Inflation Rate
Real Interest Rate
Nominal Interest Rate
After-Tax Nominal Interest Rate
After-Tax Real Interest Rate
(Percent)
(Percent)
(Percent)
(Percent)
(Percent)
1.0
4.5
 
 
 

 
8.5
4.5
 
 
 

 
Compared with lower inflation rates, a higher inflation rate will    the after-tax real interest rate when the government taxes nominal interest income. This tends to    saving, thereby    the quantity of investment in the economy and    the economy's long-run growth rate.

 

Dmitri receives a portion of his income from his holdings of interest-bearing U.S. government bonds. The bonds offer a real interest rate of 4% per year. The nominal interest rate on the bonds adjusts automatically to account for the inflation rate.

The government taxes nominal interest income at a rate of 10%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario.

Given the real interest rate of 4% per year, find the nominal interest rate on Dmitri's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario.

Inflation Rate
Real Interest Rate
Nominal Interest Rate
After-Tax Nominal Interest Rate
After-Tax Real Interest Rate
(Percent)
(Percent)
(Percent)
(Percent)
(Percent)
3.5
4.0
 
 
 

 
9.0
4.0
 
 
 

 
Compared with higher inflation rates, a lower inflation rate will    the after-tax real interest rate when the government taxes nominal interest income. This tends to    saving, thereby    the quantity of investment in the economy and    the economy's long-run growth rate.