lesson 4 quizzes and key terms: Measuring the Price Level & Inflation

hyperinflation

Prices rise at a rate of 50% per month or more

6. The process of dividing out the current price level from a nominal value and then multiplying by the base year price level to derive its real value is called _____ A. indexing B. inflating C. deflating D. disinflating E. money division

deflating

4. When the overall price level is going up but at a decreasing rate, then the economy is experiencing _____. A. deflation B. a recession C. stagflation D. falling output levels E. disinflation

disinflation

4. If you are in the working age population, the BLS counts you as either employed or unemployed. t/f?

false If you are in the working age population, the BLS counts you as either employed or unemployed OR OUT OF THE LABOR FORCE.

2. Nominal GDP is the value of output adjusted for inflation. t/f?

false REAL GDP is the value of output adjusted for inflation.

3. Real GDP equals nominal GDP in the current year only. t/f?

false real GDP is equal to nominal GDP in the BASE year only.

6. An increase in discouraged workers increases the unemployment rate. t/f?

false An increase in discouraged workers REDUCES the unemployment rate.

7. A college graduate in 1970 found a job paying $10,000 per year. The CPI was 40 in 1970. A college graduate in 2000 found a job paying $30,000 per year. The CPI was 120 in 2000. The real pay to the 2000 graduate was equal to _____ per year. A. $10,000 B. $30,000 C. $15,000 D. $25,000 E. an unknown amount

$25,000

8. If a labor contract requires the real wage to rise by 5% while the CPI equals 120 in year one and 132 in year two and if if the money wage in year one is $24, then the contract requires the money wage in year two to rise to _____. A. $25.20 B. $26.40 C. $27.72 D. $27.60 E. $30.06

$27.72

GDP deflator

. Nominal GDP divided by real GDP multiplied by 100

3. If the CPI increases from 120 in year one to 132 in year two, then the inflation rate between the two years was _____ percent. A. 12 B. 10 C. 8 D. 4 E. 32

10

15. The CPI equals 120 in year one and 132 in year two. If the nominal wage is $15 in year one and a contract calls for the real wage to increase by 4%, what will be the nominal wage in year two? A. $16.50 B. $15.00 C. $15.60 D. $17.16 E. $17.10

15. D Here are two different methods to obtain the answer. The first measures real wages directly by expressing values in base-year prices (assumed always to be 100) through dividing out current prices and multiplying by the base-year price. At a price level of 120, a nominal wage of $15 corresponds to a real wage of $12.50; that is, ($15/120)*100, which measures wages in base-year prices indicating base-year prices are 5/6 of current prices. A 4% increase would equal 1.04*12.50 or a real wage equal to $13. To determine the money wage corresponding to a real wage of $13. the wage must be valued at current prices. That is achieved by dividing out the base-year price and multiplying by the current price. At a price level of 132, the nominal wage corresponding to a real wage of $13 would be ($13/100)*132 or $17.16 to measure wages at current prices for the year, or a value 32% higher than that measured at the base-year price level. At money wage $17.16 purchasing power will have increased by 4% as required (a $13 real wage compared to $12.50). The second method looks at the inflation rate, the percentage change in the price level, new minus old all over old, which is (132 - 120)/120 or 10%. The nominal wage must increase by the inflation rate just to maintain purchasing power, or must increase by 10% to 1.10*$15 or $16.50. But to have a real wage increase of 4%, or a 4% increase in purchasing power, requires the nominal wage to increase by an additional 4%, or 1.04*$16.50 equal to $17.16.

16. If a bank deposit increases from $1200 to $1605 while at the same time (one year) the price of a shmoo increases from $12 to $15, then the SIMPLE ONE-YEAR REAL return from the deposit will be _____%. A. 8.75 B. 33.75 C. 7.00 D. 8.00 E. 7.50

16. C With nominal value $1200 at a shmoo price level of $12 each, the real value, or purchasing power would be ($1200/$12) or 100 shmoon. With $1605 at a price level of $15 each, the real value would be ($1605/$15) or 107 shmoon or a purchasing power increase of (107 - 100)/100 (or new minus old all over old) equal to 7%

2. The consumer price index for Planet Econ consists of only two items: books and hamburgers. In 2009, the base year, the typical consumer purchased 30 books for $20 each and 80 hamburgers for $5 each. In 2010, the typical consumer purchased 20 books for $40 each and 100 hamburgers for $6 each. The consumer price index for 2010 on Planet Econ equals A. 100 B. 140 C. 168 D. 120 E. 80

168

deflating

The process of dividing a nominal quantity by a price index (such as the CPI) and multiplying by its base-year price (generally 100) to express the quantity in real terms; that is, in base-year prices

17. The consumer price index basket for Planet Econ consists of only two items: books and pizzas. In 2000, the base year, the typical consumer purchased 100 books for $40 each and 100 pizzas for $10.00 each. In 2010, the typical consumer purchased 80 books for $60 each and 120 pizzas for $10.00 each. The consumer price index for 2010 on Planet Econ equals (rounding to the nearest tenth) ____. A. 88.0 B. 136.4 C. 130.0 D. 120.0 E. 140.0

17. E The CPI for any year is the cost of the standard (base-year) basket in that year using that year's prices (100*$60 + 100*$10) divided by the cost of the base-year basket in the base-year (100*$40 + 100*$10) multiplied by 100, which in this case is ($7000/$5000)*100. Thus the 2010 price level is 140.

18. If, on a deposit to a bank account, the annual NOMINAL interest rate is 8% and the annual REAL interest rate is 5%, then at the end of one year _____. A. the purchasing power of the deposit will be 8% higher B. the bank account will show a dollar balance 5% higher C. the purchasing power of the deposit will be 3% higher D. the bank account will show a dollar balance 3% higher E. the purchasing power of the deposit will be 5% higher

18. E The nominal interest rate measures the percentage increase in dollars whereas the real interest rate measures the percentage increase in purchasing power, which takes into account inflation. Since the real interest rate is 5%, the purchasing power of the deposit will be 5% higher at the end of the year. Since the nominal interest rate is 8%, the dollar balance will be 8% higher at the end of the year. The inflation rate must have been about 3% to have purchasing power increase that much less than the increase in money value.

19. Assume the CPI standard basket is 10 pizzas and 20 apples. For each of the years 2002-2005, the costs of the basket are $100, $125, $120, and $135 respectively. If 2003 is the base year, then the CPI for 2005 is _____ and the inflation rate between 2004 and 2005 is _____%. A. 135, 12.5 B. 135, -4.0 C. 108, 12.5 D. 108, -4.0 E. 112.5, 8.0

19. C The CPI for any year is equal to the cost of the standard basket in that year divided by the cost of the basket in the base year times 100. For 2004 and 2005, the CPI is 96 and 108 respectively with the inflation rate found by new - old all over old.

9. If a bank deposit earns a simple nominal return of 31.1% while at the same time (one year) the price of a shmoo increases from $10 to $12, then the SIMPLE ONE-YEAR REAL return from the deposit will be _____%. A. 8.50 B. 8.75 C. 10.50 D. 9.25 E. 11.10

9.25

10. A two-year labor contract provides for a first-year money wage of $30 per hour and specifies that the second-year REAL wage will rise by 4 percent. If the CPI is 120 in the first year and 138 in the second year, the money wage per hour that must be paid in the second year is _____ and the real wage is _____. A) $35.88; $26.00 B) $35.88; $34.50 C) $35.70; $34.50 D) $35.70; $26.00 E) $31.20; $35.88

A With an inflation rate of 15%, wages would need to increase to $34.50 just to stay even. A real increase of 4% would be 4% higher or 1.04*$34.50 equal to $35.88. The real wage is the nominal wage deflated, or ($35.88/138)*100 or $26. With a different approach, the first-year real wage is ($30/120)*100 or $25. The contracted 4% increase results in a second-year real wage of 1.04*$25 or $26. (See the solution method of question 15 for additional explanation.)

real measure

A measure that is calculated in base-year prices; that is, in physical terms since all such measures over time use the same prices

nominal (money) value

A quantity that is valued at current prices

disinflation

A situation in which prices are rising, but not as rapidly as they had been rising

deflation

A situation in which the inflation rate is negative

An increase in the inflation rate will cause lenders to have loan losses. t/f

An UNEXPECTED increase in the inflation rate will cause lenders with fixed nominal interest rate loans to have loan losses.

11. If real GDP in 2010 is larger in value than nominal GDP in 2010, then in 2010 _____. A) none of the other choices must always be true B) the price level is lower than in the base year C) physical output is lower than in the base year D) the price level is higher than in the base year E) physical output is greater than in the base year

B

12. Peg's Manicure Manor did 3,000 sets of nails in the year 2000 and 4,000 sets of nails in the year 2001. The price of a set of nails was $10 in 2000 and $12 in 2001. If the year 2000 is the base year, Peg's contribution to real GDP in 2001 was _____ . A) $36,000 B) $40,000 C) $35,000 D) $30,000 E) $48,000

B

14. If the Consumer Price Index is 135 at the end of 2001 and at the end of 2002 it is 142, then during 2002 the economy experienced A) deflation B) inflation C) hyperinflation D) indexing E) deflating

B

2. If the CPI is 200 at the end of 2010 and equals 220 at the end of 2011, then the inflation rate for 2011 equals _____. A) 20 percent. B) 10 percent. C) 25 percent D) 220 percent. E) 110 percent.

B (new-old) / old values

4. Suppose a family earned a money income of $40,000 in 2000 when the CPI was 160. By 2010, that family's nominal income increased to $80,000, while the CPI increased to 320. In 2010, the family's REAL income equaled _____. A)$80,000 B) $25,000 C) $160,000 D) $40,000 E) $50,000

B Real income is always measured in base-year prices. The process of changing a nominal value to a real value is called deflating, which involves dividing out the current price and multiplying by the base year price to measure the value in base-year prices. Here, $80,000 is divided by 320 and multiplied by 100 to measure the income in the base-year price thus turning it into a real value.

3. If the Consumer Price Index (CPI) overstates the true rate of inflation, the use of the CPI to adjust social security payments (indexing social security payments to the CPI) results in _____. A) no change in social security true real payments B) increases in social security true real payments C) decreases in social security true nominal payments D) increases in social security true nominal payments E) no change in social security true nominal payments

B) increases in social security true real payments Social security nominal payments will be increased by more than the true rate of inflation resulting in an increase in true real payments. Nominal payments could do anything depending on whether there is inflation or deflation.

shoe-leather costs

More frequent trips to the bank as a result of inflation

8. Deflating is _____. A) what occurs when prices decline B) the process of adjusting a nominal value to express it in real terms C) the process of adjusting a real value to express it in nominal terms D) the process of adjusting nominal incomes for inflation to maintain real values E) what occurs when prices increase at a decreasing rate

B) the process of adjusting a nominal value to express it in real terms

13. Inflation creates static or "noise" in the price system, making it difficult for _____. A) businesses and households to interact with each other B) lenders and borrowers to determine an appropriate level of nominal interest rate on loans C) employers and workers to determine the appropriate level of money wages to be paid D) businesses to interpret the information being transmitted by price changes E) households and businesses to hold cash

D) businesses to interpret the information being transmitted by price changes

t/f 3. A real value is indexed if it rises over time at the rate of inflation.

False: A nominal value is indexed if it rises over time at the rate of inflation.

t/f 5. If the simple nominal one-year interest rate paid on a bank deposit is 30% while at the end of one year the price level is 25% higher, then the simple one-year real rate of interest paid over the year is 5%.

False: The real interest rate is a measure of percentage change in purchasing power. Assume an initial bank deposit of, say, $1000. Assume an initial price level, of say, $10 per shmoo. Then the real value of the deposit, its purchasing power, is 100 shmoos. If the nominal interest rate is 30%, then the bank account will read $1000*(1+.30) = $1300 at the end of the year. The price of the shmoo at a 25% rate of increase will be $10*(1+.25) = $12.50 per shmoo at the end of the year. Purchasing power at the end of the year will be $1300/$12.50 shmoos equal to 104 shmoos. The real interest rate is the percentage change in purchasing power, or new minus old all divided by old, equal to 104 shmoos - 100 shmoos all divided by 100 shmoos, equal to 4/100, equal to a real interest rate of 4%, not 5%.

CPI

For any period, measures the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a base year

nominal interest rate

The percentage increase over a time period in the nominal (money) value of a financial asset

real interest rate

The percentage increase over a time period in the purchasing power of a financial asset

inflation rate

The percentage rate of change in the price level as measured, for example, by using the CPI

indexing

The practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index over that period

relative price

The price of a specific good or service in comparison to the prices of other goods and services

Choose the letter that corresponds to the best answer. (Answers are below the questions.) 1. The real value of money declines when _____. A) there is deflation B) the economy is in recession C) there is inflation D) the unemployment rate increases E) the unemployment rate decreases

The real value of money declines when there is inflation.

nominal (money) wage

The wage paid to workers measured in terms of current dollar values

real wage

The wage paid to workers measured in terms of purchasing power

To obtain the GDP deflator you can divide nominal GDP by the CPI. t/f

To obtain the GDP deflator you can divide nominal GDP by REAL GDP AND MULTIPLY BY 100.

t/f 2. If a retired person receives $10,000 in yearly social security benefits and if prices increase by 5%, then to have a 2% real increase the person would need to receive $10,710.

True: Assume the price of a shmoo is, say, $100 each. Then $10,000 in yearly income is equal to 100 shmoos per year. A 2% real increase would mean having an income equal to 102 shmoos per year; that is, 2% more than 100. A price increase of 5% would have each shmoo price equal to $105 each each; that is 5% more than $100 each. To afford 102 shmoo per year at a price of $105 each requires 102*$105 of nominal income each year; that is, $10,710 of income each year.

t/f If, in 1975, NGDP = 963.9 and the GDP deflator is 39.8, then RGDP = 2422.

True: RGDP = (NGDP/P)*100

t/f 4. A possible example of the "quality adjustment bias" of the CPI is the increase in the price index that could result when General Motors produces a higher quality car and sells it at a higher price.

True: The quality adjustment bias of the CPI fails to reflect that price changes need to be adjusted to reflect quality improvements to obtain a true measure of the price being paid.

5. Inflation can result in _____. A. confusion as to whether a price increase is a relative price increase B. can result in shoe-leather costs C. inefficient behavioral changes D. a recession caused by stabilization policy E. all of the other choices

all of the other choices

9. "Shoe leather" costs of inflation refer to the _____. A) difficulty of interpreting the price signals in an inflationary environment B) unintended changes in taxes caused by inflation C) arbitrary redistribution of wealth from one group to another D) costs of economizing on holding cash E) interference of inflation on the long-run planning of households and businesses

costs of economizing on holding cash

7. Below, using 2000 as the base year, real GDP increased by 15%: 2000: Apple: 100 bu. @ $10 Pear: 200 bu. @ $5 2001: Apple: 80 bu. @ $20 Pear: 300 bu. @ $2 t/f?

false As demonstrated below, real GDP increased by 15%. All output must be valued in base year (2000) prices to obtain real GDP. For 2000: $1000 of apples and $1000 of pears for $2000 per year real GDP For 2001: 80 bu. of apples @ $10 each ($800) and 300 bu. of pears @ $5 each ($1500) for $2300 per year real GDP. The percentage increase is ($2300 - $2000)/$2000 = $300/$2000 = 15/100 = 15%.

Nominal wages decline when prices increase more than real wages increase. t/f

false REAL wages decline when prices increase more than NOMINAL wages increase.

If a family earned a money income of $40,000 in 2000 when the CPI was 200 and a money income of $60,000 in 2004 when the CPI increased to 300, then the family's REAL income remained constant at $40,000 in both years. t/f

false Real income is always measured in the base-year price of 100 implying real income remained constant at $20,000 equal to ($40,000/200)*100 and equal to ($60,000/300)*100.

The CPI compares the current cost of the current basket with the base-year cost of the current basket. t/f

false The CPI compares the current cost of the STANDARD basket with the base-year cost of the STANDARD basket.

8. The CPI is calculated by valuing the current basket at base-year prices. t/f?

false The CPI is calculated by valuing the STANDARD basket at base-year and CURRENT prices.

The consumer price index bundle for Planet Econ consists of only two items: books and hamburgers. In 2001, the base year, the typical consumer purchased 80 books for $25 each and 200 hamburgers for $5 each. In 2005, the typical consumer purchased 40 books for $100 each and 250 hamburgers for $2 each. The consumer price index for 2005 on Planet Econ equals 150.

false The base-year basket of goods is 80 books and 200 hamburgers. The CPI measures the percentage change in the cost of this standard basket of goods with 100 being the value of the CPI in the base year. This basket costs $3000 in the base year and $8400 in 2005 for a CPI value of ($8400/$3000)*100 or 280.

The substitution bias of the CPI has to do with the arrival of new goods. t/f

false The substitution bias of the CPI has to do with consuming less of those goods becoming relatively more expensive while the CPI, by assuming a fixed basket of goods, assumes purchases are unchanged.

To obtain real income, you can multiply nominal income by GDP. t/f

false To obtain real income, you can DIVIDE nominal income by a PRICE INDEX.

The inflation rate is negative when there is disinflation. t/f

nope The inflation rate is negative when there is DEFLATION.

1. A real value refers to _____. A. a true measure of prices B. expected money values C. actual money values D. any market value E. purchasing power

purchasing power

5. When there is disinflation as measured by the Consumer Price Index, then _____. A) the purchasing power of money increases B) the CPI may be rising or falling C) the CPI is rising D) there is deflation E) the CPI is falling

the CPI is rising Disinflation implies prices are rising but at a decreasing rate.

7. Both lender and borrower agree by contract on a 5% REAL interest rate. If both originally expected a 3% inflation rate, but the inflation rate over the life of the loan turns out to be 8% instead, then _____. A) the real payments received by the lender will be lower than expected B) the real payments received by the lender will be higher than expected C) the nominal payments received by the lender will be higher than expected D) both the real and nominal payments received by the lender will be as expected E) the nominal payments received by the lender will be lower than expected

the nominal payments received by the lender will be higher than expected Since the contract guarantees the lender a fixed REAL rate, when the inflation rate rises unexpectedly, the borrower will be required to compensate the lender for the higher than expected prices providing the lender with the guaranteed real rate of return.

6. Both lender and borrower agree by contract on a 5% NOMINAL interest rate. If both originally expected a 3% inflation rate, but the inflation rate over the life of the loan turns out to be 8% instead, then _____. A) the real payments received by the lender will be lower than expected B) the real payments received by the lender will be higher than expected C) the nominal payments received by the lender will be higher than expected D) both the real and nominal payments received by the lender will be as expected E) the nominal payments received by the lender will be lower than expected

the real payments received by the lender will be lower than expected

1. Exports is a flow variable. t/f?

true

5. The labor force participation rate is the labor force divided by the working age population. t/f?

true

Inflation causes "noise" in the price system. t/f

true

The GDP deflator does not include the prices of imported goods. t/f

true