Economics Chapter 8: The Price Level and Inflation

What best describes why inflation occurs?

increased money supply, relative to the supply of goods and services

All prices rise evenly during periods of inflation and deflation.

False

Place the correct price in each blank, to reflect the effects of inflation. Use 252 as the price index for 2019.

1932- $0.9 1950- $1.05 1975- $0.66 2002- $1.19

If an economy experiences a ______% decrease in ______, this would indicate there has been a change in spending habits. Consumers and banks have decided to _______ money _______.

1st blank- 3 2nd blank- velocity 3rd blank- hold on to 4th blank- longer

Why might the prices of some products decrease whereas others increase?

Advances in technology typically cause the price of some goods to decrease over time.

The following graph shows average inflation rates and the money supply growth rates across 138 nations from 1996-2016. Select the three countries that are most likely to have the highest devaluation of money.

DR Congo Belarus Angola

Suppose the consumer price index for one year was 120 and for the next year it was 132. What is the corresponding inflation rate?

10%

Last year you paid $24 for a round of golf and $12 to rent a golf cart. This year it cost you $33 to golf and $15 to rent a cart. Based on this simple basket of goods, calculate a price index for this year using last year as the base year. Round up to the nearest whole number.

133

Max lives in Boston and earns $132,500 per year. If Max decides to move to San Francisco, what annual salary will he need to make in order to maintain the same real wage?

164,000

Suppose the current CPI is 252 and in 2005 it was 196. A pair of Levi's jeans costs $43 today. Based on the CPIs, what would you expect the 2005 price to have been for the same style of Levis, in a similar retail outlet? Round your answer to two decimal places.

$33.44

If, in a given year, the money supply changes by +2%, the price level changes by +3.5%, and GDP changes by -1%, what is the change in the velocity of money?

+0.5%

The velocity of money is the frequency with which money _______. The greater the money velocity, the _______ goods and services are being traded. By the equation of exchange, the money velocity times ______ equals the price level times ______.

1st blank- changes hands 2nd blank- more 3rd blank- the size of the money supply 4th blank- real GDP

You live in Atlanta and earn $95,600 a year. Your boss offers you a $10,000 raise and the opportunity to move to another city and work remotely. If maintaining at least the same real wage is your only concern, select all the cities to which you could relocate.

Dallas, TX Charlotte, NC Detroit, MI Phoenix, AZ Richmond, VA

The following diagram illustrates the dilemma that firms face when they cannot tell which price changes are due to inflation. Place the following events onto the diagram to indicate whether they represent real increase in demand or inflation.

Increase output- +2% increase in income, which makes all goods and services more affordable +growth in population Don't change output- +rising housing prices with no change in housing consumption +3% increase in money supply, but no changes in velocity or real GDP

Surprise inflation can help people who have borrowed money.

True

Fill in the blanks to complete the passage about the CPI and the GDP deflator. The Consumer Price Index (CPI) and the GDP deflator are both price indices, so they both serve as measures of inflation. However, the ________ uses a smaller basket of goods. The ______ aims to take into account all final goods and services, whereas the _________ only includes goods and services sold to ________. So, for instance, prices on farm equipment are included in the __________ but not in the _______.

1st blank- CPI 2nd blank- GDP deflator 3rd blank- CPI 4th blank- consumers 5th blank- GDP deflator 6th blank- CPI

Mary's costs will rise, and for revenue to keep pace she will have to _____ to keep her prices consistent with inflation. If Mary mistakenly believes the rising price of seafood is the result of increased _______, she may misdirect restaurant resources. This would be an example of price _______.

1st blank- deal with menu costs 2nd blank- demand 3rd blank- confusion

Fill in the blanks to complete the passage on price doubling. Prices doubling every day makes it _____ for the average citizen to afford goods of ______, which they must have to live. Such increases in price are an example of _______.

1st blank- difficult 2nd blank- necessity 3rd blank- hyperinflation

Two things tempt governments to enact inflationary policies. The first is _______ , which can be paid off by _______. The second is _______ economy, which in the short term can be jump-started by a _______ increase in the money supply.

1st blank- government debt 2nd blank- printing money 3rd blank- a sluggish 4th blank- surprise

Fill in the blanks to complete the explanation of how inflation and deflation affect consumers differently. Inflation occurs when the overall prices of goods _______. This means that consumers have ______ purchasing power. Deflation occurs when the overall prices of goods ______. When this happens, consumers have _______ purchasing power.

1st blank- increase 2nd blank- less 3rd blank- decrease 4th blank- more

The chained CPI is _____ than the traditional CPI. The chained CPI is updated _____ in an effort to compensate for the _____ of new products. The traditional CPI has an ______ bias of about 1% per year _____ actual price changes.

1st blank- more accurate 2nd blank- monthly 3rd blank- prices 4th blank- upward 5th blank- above

Your parents bought their first car for $5,000. The price level in the year your parents bought their car was 50, whereas the price level today is 252. Calculate how much your parents' car would have cost if they bought it today.

25,200

Suppose the inflation rate is 2% per year. If you currently think of $40,000 as an acceptable retirement income and are expecting to retire in 40 years, what will the equivalent annual income then be, adjusted for inflation rate of 2% per year? Round your answer to the nearest dollar.

88,400

Take 2017 as the price index base year. That year, you paid $80 for a day at a theme park. In 2019, the price was up to $84. Assuming that the increase reflects the inflation rate and that this rate continues in 2019, match each number to its description.

88.2-the cost of a theme-park visit in 2019 dollars 5-the inflation rate as a percentage 105- the 2018 price index 110.25- the 2019 price index

Select the case(s) in the following table that demonstrate no change in the overall cost of goods and services.

Case 2

Gwyn owns a furniture store. She notices prices at other furniture stores have increased dramatically over the past two years. She decides she needs to expand her output because demand must be growing. However, in order to do so, she needs to find a loan. What problems could inflation cause for Gwyn in this situation?

Correct answers- +Lenders may be wary of providing Gwyn a loan because it is difficult to predict future price levels. +Gwyn may need to spend money to update her price displays throughout the store. +Gwyn might misinterpret rising prices associated with inflation for a higher demand. Incorrect answers- +Gwyn will need to pay more capital gains taxes.

Which of the following problems can inflation cause for suppliers?

Correct answers- +Long-term agreements become too risky for lenders, making it more difficult to obtain a loan. +Prices begin to rise, so firms increase output. Incorrect answers- +higher demand +lower prices

What are the three reasons why the CPI is hard to measure accurately?

Correct answers- +new products to buy and new ways for consumers to buy them +changes in the quality of the same good, over time +consumers substituting one good for another because of price Incorrect answers- +the difference between nominal and real buying power +changes in the tax rate and therefore in take-home income

Which of the following may be considered as part of the consumer price index?

Correct- Food Housing Transportation Incorrect- taxes investments

The following table shows past prices of products you may use today converted into modern dollar values. Select the photos of the products that are more expensive in today's actual price than they were in the earlier time periods in today's dollars (2018), as indicated in the table.

Hersheys bar

What is the main advantage of the Billion Prices Project over the CPI?

Many prices can be monitored daily.

Suppose you're working in your hometown. You have an opportunity to take a new job in a different city, where the cost of living is different. In each of the following situations, would your real wage be higher or lower in the new job?

Real Wages Would Be Higher- The cost of living in the new city is 8% higher, and you'd get a raise of 10%. The cost of living in the new city is 10% lower, and you'd take a 5% pay cut. The cost of living in the new city is 3% lower, and you'd be paid the same amount. Real Wage Would Be Lower- The cost of living in the new city is 12% higher, and you'd get a raise of 10%.The cost of living in the new city is 3% lower, and you'd be paid the same amount

Which of the following scenarios is most likely to lead to inflation?

Scenario Likely to Lead to Inflation- +The government prints $500 million in new currency to finance current infrastructure spending. +The quantity of goods and services in the economy increases by 2% while the supply of money increases by 4%. Scenario Not Likely To Lead To Inflation +The supply of money decreases. +The population of a nation decreases.

What could happen if the CPI is under-calculated and neither workers nor employers are aware of this?

Wages will be too low.

The graphic shows the timeline of production, beginning with preparations and ending with the output being sold to customers. Suppose there is uncertainty about the amount of inflation that will occur during the time period between the signing of contracts and the collection of sales revenue (which is the production period). Label each item solely based on a worry that inflation will be higher than expected or that it will be lower than expected.

Will Come True if Inflation Is Higher Than Expected After Contracts Are Signed- +The workers worry that they agreed to lower wages than they should have. +The lender worries that the loan rate is too low. Will Come True if Inflation Is Lower Than Expected After Contracts Are Signed- +The business owner worries that the loan rate is too high. +The business owner worries about not being able to charge high enough prices.

Click on the area of the timeline when the U.S. Consumer Price Index dropped significantly from the year before, altering the type of inflation experienced in the economy.

between 2005 and 2015

Which of the following scenarios make it difficult to accurately measure the CPI?

correct answers- +A company releases a new product that many consumers adopt. +The price of a ticket to a baseball game increases after the stadium is rebuilt. incorrect answers- +Consumers need to purchase gas to get to work. +The typical basket of consumer goods does not change.

Drag each item on the left to its matching item on the right. Note that every item may not have a match, while some items may have more than one match.

money illusion- The normal rate of inflation is about 3%. Hector notices the cost of a movie increases by 3% and decides not to go because he mistakenly concludes that movies have become more expensive. shoe-leather costs- Because of extremely high inflation, David makes small weekly cash withdrawals instead of large monthly ones. money illusion- Selena decides to move to a city with a very high cost of living, for a job with a slightly higher salary. menu costs- Inflation forces a car dealership to increase its prices and pay for frequent ads in the newspaper to announce the changes.

Match each term related to inflation-imposed costs on an economy to the appropriate example.

price confusion- Tarik is the manager of a car dealership selling hybrid vehicles. He notices the prices rising for the vehicles but is uncertain whether it is the greater demand for hybrid vehicles that is causing prices to rise. money illusion- Malika's wage increases by 12% and the prices at her favorite restaurant, along with all other prices, rise by the same percentage. She decides to no longer eat at her favorite restaurant because she feels it is now too expensive. shoe-leather costs- Caleb makes frequent trips to the bank to make withdrawals so as to avoid the "tax" of inflation.

Match the situation to the factor that affects the accuracy of the CPI.

substitution- The cost of cable increases. People decide to switch to Netflix instead. changes in quality- Newer cars have built-in GPS and Bluetooth capabilities. new products- A new smartphone app solves math problems simply by pointing the camera at the page. changes in quality- Video game consoles offer better graphics and gameplay than they did a decade ago. new location- New pop-up stores at airports sell clothing, personal electronics, and designer eyewear at low prices. substitution- The cost of bananas increases dramatically. Many people switch to oranges because they are cheaper.

Thirty years ago Daniel bought a plot of land for $50,000 when the CPI was 50. Now the CPI is 180 and he sold the land for $180,000. What issue might inflation cause for Daniel?

tax distortions

Match the situation to the inflation-related problem it illustrates.

uncertainty about future price levels- Unstable inflation makes it difficult for lenders to anticipate the value of their money in the future. price confusion- Producers are unable to determine how much output to produce. wealth redistribution- A surprise increase in inflation devalues borrowers' future payments to lenders.