AP Marco: Edge Ex: Real and Nominal Values

How would your borrowers feel if inflation were actually 6%?

Borrowers would like it if inflation were 6%, as the resulting negative real interest rate indicates that the real value of the amount repaid at the end of the loan period will be less than the real value of the amount borrowed.

Which of the following is the accumulated value of a household's savings?

Wealth

Inflation and expected inflation are important determinants of economic activity. If there is an increase in the expected rate of inflation, will the real interest rate on new loans increase, decrease, or remain unchanged?

When expected inflation rises, the real interest rate on new loans will remain the same. The expected inflation will be built into the nominal interest rate instead.

If the actual inflation rate is greater than the expected inflation rate, then

borrowers win (The real interest rate is calculated as the nominal rate minus inflation. Therefore, when inflation is greater than what was expected, the real interest rate will be lower than what was expected. A lower real interest rate is good for borrowers but bad for lenders.)

If the interest rate falls, then:

the opportunity cost of investment is less.

The annual inflation rate is expected to be 2 percent over the next four years. If you take out a four-year loan at a nominal interest rate of 6 percent, what real interest rate are you paying?

4% (The real interest rate can be calculated as the nominal rate minus expected inflation.)

In the country of Agronomia, banks charge 10 percent interest on all loans. If the general price level has been increasing at the rate of 4 percent per year, the real rate of interest in Agronomia is:

6 Percent (The relationship between these values is: real interest rate = nominal interest rate - inflation. Therefore, real interest rate = 10% - 4%, or 6%.)

The annual inflation rate is expected to be 5 percent over the next 3 years. Juan plans to take out a 3-year loan to purchase a car. If Juan decides not to take out a loan if the real interest rate exceeds 3 percent, the highest nominal interest rate he is willing to pay is:

8 Percent (The relationship between these values is: nominal interest rate = real interest rate + expected inflation. Therefore, nominal interest rate = 3% + 5% = 8%.)

The value of which of the following is counted in the United States gross domestic product?

A car produced in the United States and sold in Europe

How would your borrowers feel if inflation were actually 1%?

Borrowers would not like it if inflation were only 1%, as that would mean they are paying a real return of 4% instead of 3%.

Inflation and expected inflation are important determinants of economic activity. If there is an increase in the expected rate of inflation, will the nominal interest rate on new loans increase, decrease, or remain the same?

If there is an increase in the expected rate of inflation then the nominal interest rate on new loans will increase.

Which of the following can be concluded about the consumer price index (CPI) for this individual from 2003 to 2004?

It increased by 25%. (The cost of the market basket in 2003 was $80 (5*$6 + 2*$7 + 3*$12). The cost of the market basket in 2004 was $100 (5*$5 + 2*$9 + 3*$19). That is a 25% increase ($20/$100).

Which of the following would be true if the actual rate of inflation were less than the expected rate of inflation?

People who borrowed funds at the nominal interest rate during this time period would lose.

As the price level decreases, what happens to the purchasing power of wealth, and what does that mean about aggregate demand?

Purchasing power of wealth: Increases Aggregate demand: Downward Sloping (When the price level falls, every dollar can buy more, so the purchasing power of wealth has increased. This means that the quantity of consumption expenditures will increase, leading to a greater level of output. The inverse relationship between the price level and the output level means that aggregate demand is downward sloping.)

Which of the following best explains why transfer payments are not included in the calculation of gross domestic product?

Recipients of transfer payments have not produced or supplied goods and services in exchange for these payments.

As the lender, how would you feel if inflation were actually 1%? (went from 2% to 1%, start 5%)

That would be beneficial, as the real return would increase to 4% (5% - 1%).

As the lender, how would you feel if inflation were actually 6%?

That would be detrimental, as the real return would decrease and actually become negative (5% - 6% = -1%). In other words, you are not even being compensated enough to account for inflation.

If the nominal gross domestic product (GDP) of the nation of Hypothetica increased in 2007 relative to the previous year, it must be true that in Hypothetica in 2007

The price level and/or the real GDP has increased.

If real gross domestic product is increasing at 6 percent per year and nominal gross domestic product is increasing at 5 percent per year, which of the following is necessarily true?

The price level is decreasing. (Real GDP controls for changes in prices over time. So, output has grown by 6% with prices held constant. When prices are allowed to change over time (nominal GDP), GDP grows more slowly, which means that the price level must be falling.)

If real gross domestic product (GDP) is increasing at 3 percent per year and nominal gross domestic product is increasing at 7 percent per year, which of the following is necessarily true?

The price level is increasing. correct

Inflation and expected inflation are important determinants of economic activity. Assume that the nominal interest rate is 8 percent. Borrowers and lenders expect the rate of inflation to be 3 percent and the growth rate of real domestic product is 4 percent. Calculate the real interest rate.

The real interest rate would be 5% which you get from subtracting 3% from 8%.

If a worker's nominal wage rate increases from $10 to $12 per hour and at the same time the general price level increases by 10 percent, the worker's real wage has:

approximately increased by 10% (The nominal wage increased by 20% ($2/$10). But since prices increased by 10%, real wages increased by only 10% (20% - 10%).

If inflation is 3 percent at the time when a worker's nominal income increases from $50,000 to $52,500, then the worker's real income has:

approximately increased by 2%. (The worker's nominal wage increased by 5% (2,500/50,000). Because inflation is 3%, the worker's real wage increased by 2% (5% - 3%).)

The major difference between real and nominal gross domestic product (GDP) is that real GDP:

is adjusted for price-level changes using a price index.

The aggregate demand curve is downward sloping because as the price level increases the:

purchasing power of wealth decreases