4.5.5: The Costs of Inflation

When the government raises revenue by printing money, it is said to have imposed an inflation tax. Select one: True False

True The inflation tax is a cost of inflation imposed by the government as a result of its spending.

The idea that inflation results in businesses having to change price tags and listings often is called the ______________ of inflation. Select one: a. menu cost b. shoeleather cost c. relative-price variability cost d. inflation-induced tax distortion

a. Menu costs are the costs of communicating price changes to customers. These added costs are passed on to customers as higher prices.

If the nominal interest rate is 6% and the inflation rate is 3%, the real interest rate is Select one: a. 3%. b. 6%. c. 9%. d. 10%.

a. The real interest rate is the nominal rate, 6%, minus the inflation rate, 3%.

An inflation tax is Select one: a. a tax on people who hold money. b. a tax charged to businesses based on the increase in their prices. c. used by governments when they have a surplus. d. a tax on people who hold certificates of deposit.

a. The so-called inflation tax means that the government prints money to pay its bills. When it does this, it decreases the value of the money supply. Those individuals who hold physical assets or interest-bearing assets are not hurt as badly as the people who hold money are hurt.

Suppose you have a business selling wholesale auto parts to dealers and car repair shops. Because of inflation you must print and mail out new price lists every month. The costs would be an example of Select one: a. menu costs. b. shoeleather costs. c. confusion. d. redistribution of wealth.

a. This example is a menu cost. It is similar to a restaurant changing the menu prices daily.

Which of the following individuals would be harmed the most by an unanticipated change in the rate of inflation? Select one: a. People who have cost-of-living adjustments built into their incomes. b. Bankers who lend money at fixed interest rates. c. People who borrowed money at lower interest rates. d. People whose nominal incomes are rising faster than inflation.

b. Institutions that lend money at fixed interest rates are damaged by unanticipated inflation. They have locked in contracts at fixed rates because they failed to correctly predict the rate of inflation. The value of the money being re-paid to them has lost some of its purchasing power.

To avoid the inflation tax, people Select one: a. hold all of their wealth in the form of cash. b. do not hold money. c. do not file an income tax return. d. do nothing because the inflation tax is unavoidable.

b. Printing money to finance government expenditures imposes an inflation tax on everyone who holds money. So a way to avoid this tax is not to hold money.

Suppose that Bolivia is experiencing hyperinflation and people go to the bank every day to get cash and then buy their daily needs immediately. This would be an example of Select one: a. menu costs. b. shoeleather costs. c. confusion costs. d. redistribution of wealth.

b. This question is an example of shoeleather cost. The people in Bolivia spend a lot of time getting cash and shopping, thus wearing out shoeleather.

Shoeleather costs of inflation refer to Select one: a. the decline in real income associated with inflation. b. the decline in purchasing power associated with inflation. c. the waste of resources as people attempt to minimize their holdings of money. d. the fact that inflation increases the prices of goods, including shoeleather.

c. Shoeleather costs are the result of the choice of consumers to keep more of their money in the bank rather than hold cash in their pockets. Consumers now have to go back and forth to the bank to withdraw money more frequently. This time spent withdrawing money is representative of wasted productivity and resources.

Printing money to finance a government program Select one: a. imposes a tax on everyone who holds money. b. reduces the opportunity cost of the program. c. is exactly like imposing an income tax to pay for the project. d. all of the above.

d. Printing money to finance a government program causes all of these events to occur.

Which of the following costs of inflation shrink consumer wealth? Select one: a. Shoeleather costs b. Menu costs c. Misallocation of resources d. All of the above shrinks consumer wealth.

d. Shoeleather costs, menu costs, and misallocation of resources are three costs of inflation that shrink consumer wealth.