Chapter 17 :(

Bertha purchased 10 shares of BestSnack, Inc. stock for $200 per share; in one year, she sold the 10 shares for $220 a share. Over the year, the inflation rate was 3%. If the tax rate on nominal capital gain is 50%, how much tax does Bertha pay on her gain?

$100. Bertha's capital gain is ($220 - $200) x 10 = $200, of which the government takes 50%, leaving her with $200 x (1 - 0.50) = $100. Note that the remaining 3% is taken by inflation, not the government.

Bertha bought 10 shares of iSnack stock for $1 per share. In one year, she sold 5 shares for $5 a share. During this year, the price level increased from 140 to 147. What is Bertha's before-tax real capital gain?

$19. The inflation rate is 100 x ((147 - 140)/140) = 5%. Bertha paid $5 for five shares last year. Now, she sold them for $5 per share, making 5 x $5 = $25 while gaining $25 - $5 = $20. Of her $20 gain, 5% is lost to inflation: $20 - $20 x 0.05 = $19.

Bertha bought 10 shares of iSnack stock for $1 per share. In one year, she sold 5 shares for $5 a share. During this year, the price level decreased from 147 to 140. What is Bertha's before-tax real capital gain?

$21. The inflation rate is 100 x ((140 - 147)/147) = -5%. Bertha paid $5 for five shares last year. Now, she sold them making 5 x $5 = $25, gaining $25 - $5 = $20. However, since the price level has decreased, Bertha is actually gaining more: $20 - ($20 x (-0.05)) = $21.

Bertha purchased 100 shares of BestSnack, Inc. stock for $20 per share; in one year, she sold the 100 shares for $25 a share. Over the year, the inflation rate was 3%. If the tax rate on nominal capital gain is 50%, how much did Bertha earn?

$242.5. Bertha's capital gain is ($25 - $20) x 100 = $500, of which the government takes 50%, leaving her with $500 x (1 - 0.50) = $250. Of this amount, 3% is lost to inflation, which means that Bertha earns only $250 x (1 - 0.03) = $242.5.

Bertha purchased 100 shares of BestSnack, Inc. stock for $20 per share; in one year, she sold the 100 shares for $25 a share. Over the year, the inflation rate was 3%. If the tax rate on nominal capital gain is 50%, how much tax does Bertha pay on her gain?

$250 Bertha's capital gain is ($25 - $20) x 100 = $500, of which the government takes 50%, leaving her with $500 x (1 - 0.50) = $250. The remaining 3% is taken by inflation, not the government.

Bertha purchased 10 shares of BestSnack, Inc. stock for $200 per share; in one year, she sold the 10 shares for $220 a share. Over the year, the inflation rate was 3%. If the tax rate on nominal capital gain is 50%, how much does Bertha earn?

$97. Bertha's capital gain is ($220 - $200) x 10 = $200, of which the government takes 50%, leaving her with $200 x (1 - 0.50) = $100. Of this amount, inflation takes another 3%: $100 x (1 - 0.03) = $97.

Suppose the nominal interest rate is 8%, the inflation rate is 3% and the tax rate is 45%. What is after-tax real rate of interest?

1.4%. The government takes 45% of the nominal rate of 8%, leaving an after-tax nominal interest rate of only 8% - (8% x 0.45) = 4.4%. Thus the after-tax real interest rate is 4.4% - 3% = 1.4%.

Suppose the Consumer Price Index has increased from 105 to 107. What is the inflation rate?

1.9% Inflation is measured as a percentage change in the overall price level: 100 x ((107 - 105)/105) = 1.9%.

The real interest rate is 4%, inflation is 2%, and the marginal income tax rate is 25%. What is after-tax real rate of interest?

2.5% The income tax treats this entire nominal interest of 4% + 2% = 6% as income, the government takes 25% of it, leaving an after-tax nominal interest rate ofonly 6% - (6% x 0.25) = 4.5%. The after-tax real interest rate is 4.5% - 2% = 2.5%.

The real interest rate is 5%, inflation is 3%, and the marginal income tax rate is 25%. What is after-tax real rate of interest?

3%. The income tax treats this entire nominal interest of 5% + 3% = 8% as income, the government takes 25% of it, leaving an after-tax nominal interest rate of only 8% - (8% x 0.25) = 6%. The after-tax real interest rate is 6% - 3% = 3%.

Suppose P is the price level (the GDP deflator), Y the quantity of output (real GDP), V is velocity, and M the quantity of money if M = 600, V = 5, and Y = 1000, what is the price level?

3. Based on the quantity equation, P = (V x M) / Y = (5 * 600) / 1,000 = 3.

The nominal interest rate is 10%, inflation is 4%, the marginal income tax rate is 25%. What is after-tax real rate of interest?

3.5% The government takes 25% of the nominal rate of 10%, leaving an after-tax nominal interest rate of only 10% - (10 x 0.25) = 7.5%. Thus the after-tax real interest rate is 7.5% - 4% = 3.5%.

Suppose the price level has increased from 103 to 107. Which of the following is the inflation rate?

3.88% Inflation is measured as a percentage change in the overall price level: 100 x ((107 - 103)/103) = 3.88%.

Suppose the nominal interest rate is 6% and the inflation rate is 2%. What is the real interest rate?

4%

Suppose the Consumer Price Index has increased from 100 to 105. What is the inflation rate?

5%

Consider an economy producing only widgets, which cost $2 each. If you have $100, what is the real value of the money you hold?

50 widgets. If the price of widgets increases, you will need more money.

Suppose P is the price level (the GDP deflator), Y the quantity of output (real GDP), and M the quantity of money. If M = 1,000, P = 2, and Y= 3,000, what is velocity (V)?

6 The velocity of money is calculated by dividing the nominal value of output (nominal GDP) by the quantity of money. If P is the price level (the GDP deflator), Y the quantity of output (real GDP), and M the quantity of money, then V = (P x Y)/M = (2 x 3,000)/1,000 = 6.

The nominal interest rate is 12%, inflation is 3%, the marginal income tax rate is 10%. What is after-tax real rate of interest?

7.8%. The government takes 10% of the nominal rate of 12%, leaving an after-tax nominal interest rate of only 12% - (12% x 0.10) = 10.8%. Thus the after-tax real interest rate is 10.8% - 3% = 7.8%.

Suppose P denotes the price of goods and services measured in terms of money.

A decrease in the value of money is associated with an increase in P. If P is the price of goods and services measured in terms of money, then 1/P is the value of money measured in terms of goods and services. If P decreases, the value of money increases. And vice versa.

Which of the following describes the relationship between the value of money and the price level?

As the price level falls, the value of money rises. As the price level falls, the value of money rises because less money is needed to buy a representative basket of goods.

Which of the following describes the relationship between the value of money and the price level?

As the price level rises, the value of money falls. As the price level rises, the value of money falls because more money is needed to buy a representative basket of goods.

Which of the following describes monetary neutrality?

Changes in the supply of money affect nominal variables but not real ones.

Bertha lends $1,000 to Danko for 2 years and charges an annual interest rate of 6%. Bertha had anticipated the inflation rate of 2%, but it actually turned to be 2.5%. In two years, as a result of the higher-than-expected inflation,

Danko is better off at the expense of Bertha. Higher than expected inflation makes borrowers better off at the expense of the lenders because it diminishes the real value of the debt.

When inflation was expected to be high and it turns out to be low, wealth is redistributed from creditors to debtors.

FALSE. Unexpected changes in prices redistribute wealth among debtors and creditors. Lower than expected inflation makes lenders (creditors) better off at the expense of the borrowers (debtors) because it increases the real value of the debt as the real interest rate is the difference between the nominal interest rate and the inflation rate.

In the U.S., people are required to pay taxes on real capital gains irrespective of their nominal capital gains.

FALSE. One example of how inflation discourages saving is the tax treatment of capital gains-the profits made by selling an asset for more than its purchase price.

As the price level increases, the value of money increases.

False. A rise in the price level means a lower value of money because each dollar in your wallet now buys a smaller quantity of goods and services.

The immediate effect of a monetary injection increases the economy's ability to supply goods and services.

False. The immediate effect of a monetary injection is an excess supply of money. The economy's ability to supply goods and services, however, does not change as it is determined by the available labor, physical capital, human capital, natural resources, and technological knowledge.

There are no costs of deflation.

False. Deflation causes the value of debts to increase in real terms, transferring money from debtors to creditors. It also has menu costs and relative price variability.

Bertha took out a 5-year fixed-interest-rate loan. She has anticipated the inflation rate of 3% but it actually turned to be only 2%.

Her real interest rate was higher than expected, and the real value of the loan is higher than expected. Unexpected changes in prices redistribute wealth among debtors and creditors.

Bertha took out a 5-year fixed-interest-rate loan. She has anticipated the inflation rate of 2% but it actually turned to be 4%.

Her real interest rate was lower than expected, and the real value of the loan is lower than expected. Unexpected changes in prices redistribute wealth among DEBTORS and CREDITORS.

Which of the following is true about inflation and relative prices?

Higher inflation increases the relative-price variability distorting the resource allocation. As high inflation distorts relative prices, consumer decisions are distorted and markets are less able to allocate resources to their best use.

Which of the following reforms would allow for the taxation of only real interest earnings?

Indexing the tax system to take into account the effects of inflation. The tax laws could be reformed to adjust the purchase price using a price index and assess the tax only on the real gain. I

Which of the following is true about the inflation tax in the United States?

It falls most heavily on those who hold a lot of currency but accounts for a small share of U.S. government revenue. When the government prints money, the price level rises, and the dollars in your wallet are less valuable. Thus, the inflation tax is like a tax on everyone who holds money. Thus it is said that by printing money, the government levies an inflation tax. In the United States in recent years, the inflation tax has been a trivial source of revenue for the government.

Why do people believe in the inflation fallacy?

People tend to forget that inflation in prices goes hand in hand with inflation in incomes. When prices rise, buyers of goods and services are worse off but at the same time, sellers are better off. Because most people earn their incomes by selling their services, such as their labor, inflation in incomes goes hand in hand with inflation in prices. Thus, inflation does not in itself reduce people's real purchasing power.

Which of the following explains why the demand curve for money is downward sloping?

People want to hold a larger quantity of money when each dollar buys less.

Which of the following describes how inflation can be measured?

Percentage change in the GDP deflator. Inflation is measured as a percentage change in the consumer price index (CPI), the GDP deflator, or some other index of the overall price level.

Which of the following describes how inflation is usually measured?

Percentage change in the consumer price index. Inflation is measured as a percentage change in the consumer price index (CPI), the GDP deflator, or some other index of the overall price level.

When higher inflation reduces the value of money,

Shoeleather costs of inflation increase.

Which of the following is an example of menu costs?

Stores advertising new prices.

When inflation turns out to be higher than expected, wealth is redistributed from lenders to borrowers.

TRUE. Higher than expected inflation makes borrowers better off at the expense of the lenders because it diminishes the real value of the debt.

The nominal interest rate is 8%, inflation is 1%, the marginal income tax rate is 10%. What is after-tax real rate of interest?

The government takes 10% of the nominal rate of 8%, leaving an after-tax nominal interest rate of only 8% - (8% x 0.10) = 7.2%. Thus the after-tax real interest rate is 7.2% - 1% = 6.2%.

Which of the following describes the effect of a decrease in the money supply?

The money supply curve shifts to the left, the price level decreases causing the value of money to increase. The price level decreases, making each dollar more valuable.

Which of the following describes the effect of an increase in the money supply?

The money supply curve shifts to the right, the price level increases causing the value of money to decrease. An increase in the money supply makes dollars more plentiful, the price level increases, making each dollar less valuable.

Which of the following is the immediate effect of a monetary injection?

The money supply increases, whereas the economy's ability to supply goods and services does not change.

Which of the following describes the Fisher effect?

The nominal interest rate adjusts to the inflation rate.

Which of the following explains why the supply curve for money is vertical?

The quantity of money supplied is fixed by the Federal Reserve. The demand curve for money is downward sloping because people want to hold a larger quantity of money when each dollar buys less.

Which of the following describes the money equilibrium in the long run?

The quantity of money that people want to hold equals the quantity of money supplied by the Fed.

Which of the following theories can explain both inflation and hyperinflation?

The quantity theory of money. The quantity theory of money asserts that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate.

Which of the following theories explains the long-run determinants of the price level and the inflation rate?

The quantity theory of money. According to this theory, the quantity of money available in an economy determines the value of money, and growth in the quantity of money is the primary cause of inflation.

In the U.S., the income tax treats the nominal interest earned on savings as income, even though part of the nominal interest rate merely compensates for inflation.

True.

When inflation rises, the nominal interest rate rises, and people desire to hold less money

True.

When inflation was expected to be high and it turns out to be low, wealth is redistributed from debtors to creditors.

True.

An increase in the value of money decreases the price of goods and services measured in terms of money.

True. If P is the price of goods and services measured in terms of money, then 1/P is the value of money measured in terms of goods and services.

When deciding how much to save, people care most about before-tax nominal interest rates.

True. The income tax treats the nominal interest earned on savings as income, even though part of the nominal interest rate merely compensates for inflation.

Which of the following describes the meaning of the demand for money?

Wealth that people want to hold in liquid form. The amount of cash that people hold in their wallets depends on how much they rely on credit cards and on whether an automatic teller machine is easy to find.

As the price level decreases, the value of money

increases, so people want to hold less of it.

As inflation rises,

menu costs and shoeleather costs of inflation increase.

The inflation tax is not exactly like other taxes because

no one receives a bill from the government for the tax.

One cost of deflation is ____

redistribution of wealth toward creditors and away from debtors. Deflation causes the value of debts to increase in real terms, transferring money from debtors to creditors.

During the 1770s, the United States ____

relied heavily on the inflation tax.

Bertha owns a pastry shop and café in an economy that is prone to rapid inflation. If Bertha reprints her menu every month,

she bears a high menu cost and the relative price of her pastries is too low. Market economies rely on relative prices to allocate scarce resources as consumers decide what to buy by comparing the quality and prices of various goods and services.

As the price level increases,

the value of money decreases. As the price level increases, the value of money decreases, so people must hold more money to purchase goods and services.

The principle of monetary neutrality implies that

an increase in the money supply will increase the price level, but not real GDP.