Inflation Pt. 1 & 2

According to economic theory, which of the following expressions can possibly represent the (general) demand for money (real)? A) 100+1. B) 100/(i + Y.) C) 100 - 0.5* i + 0.2* .Y D) none of the above.

C) 100 - 0.5* i + 0.2* .Y since demand for money depends negatively (inversely) on nominal interest rate, and positively on real income

If nominal GDP is $1,000, then fi there in $200 of money in the economy, velocity is times per year. A) 0.2 B) 2 C) 5 D) 10

C) 5 use the equation M*V = P*Y = nominal GDP.

The demand for real money balances is generally assumed to: A) be exogenous. B) be constant. C) increase as real income (real GDP) increases. D) decrease as real income increases

C) increase as real income (real GDP) increases.

12. The real interest rate is equal to the: A) amount of interest that a lender actually receives when making a loan. B) nominal interest rate plus the inflation rate. C) nominal interest rate minus the inflation rate. D) nominal interest rate.

C) nominal interest rate minus the inflation rate.

The rate of inflation is the: A) median level of prices. B) average level of prices. C) percentage change in the level of prices. D) measure of the overall level of prices.

C) percentage change in the level of prices.

According to the quantity theory of money, ultimate control over the rate of inflation in the United States si exercised by: A) the Organization of Petroleum Exporting Countries (OPEC). B) the U.S. Treasury. C) the Fed. D) private citizens.

C) the Fed. we can see for any fixed Y and V, M is proportional to P. It means any change in M (controlled by the Fed) would lead to changes in P (inflation)

13. If the nominal interest rate is I percent and the inflation rate is 5 percent, the real interest rate is: A) 1 percent. B) 6 percent. C) 4- percent. D) 5- percent.

C) 4- percent.

The definition of hte velocity of money, V, is: A) money multiplied by prices divided by real GDP. B) transactions divided by prices multiplied by money. C) Prices multiplied by all business transactions divided by money supply. D) price (index) multiplied by real GDP divided by money supply.

D) price (index) multiplied by real GDP divided by money supply.

If the average price (P) of goods and services in the economy equals $10 and the quantity of money in the economy equals $200,000, then real balances in the economy equal: A) 10 B) 20,000 C) 200,000 D) 2,000,000

B) 20,000

5. Real money balances equal the: A) sum of coin, currency, and balances in checking accounts. B) amount of money expressed in terms of the quantity of goods and services it can purchase. C) number of dollars used as a medium of exchange. D) quantity of money created by the Federal Reserve.

B) amount of money expressed in terms of the quantity of goods and services it can purchase. real money balances or real money supply = M / P, where P = price per unit of goods.

17. The opportunity cost of holding money is the: A) real interest rate. B) nominal interest rate. C) inflation rate. D) none of the above.

B) nominal interest rate. because by holding money, not only one miss out on the real return (r ), but there is loss due to inflation (lowering of purchasing power), and the nominal interest rate is the sum of real rate/return and inflation rate.

The general demand function for real (money) balances depends on the nominal interest rate and: A) investment expenditure. B) real income. C) the price level. D) none of the above.

B) real income.

The quantity theory of money assumes that A) nominal income is constant. B) velocity is constant. C) prices are constant. D) none of the above.

B) velocity is constant.

21. If the Fed announces that it will raise the money supply in the future but does not change the money supply today, A) both the nominal interest rate and the current price level will decrease. B) the nominal interest rate will increase and the current price level will decrease. C) the nominal interest rate will decrease and the current price level will increase. D) both the nominal interest rate and the current price level will increase.

D) both the nominal interest rate and the current price level will increase. nominal rate will increase because of increase in expected inflation rate. If nominal rate goes up, the demand for real balances will go down, hence for the money market to be in equilibrium, the supply of real balances, M/ P, has to decrease, which means prices have to go up assuming that there is no change in M.

22. The characteristic of the classical model that the money supply does not affect real variables is called: A) the monetary basis. B) monetary policy. C) the quantity theory of money. D) monetary neutrality

D) monetary neutrality

10. If velocity is assumed to be constant, but no other assumptions are made, the level of ___________ is determined by M. A) prices B) real income C) transactions D) nominal GDP

D) nominal GDP

If the velocity ofmoney remains constant while the quantity of money (M) doubles, then: A) price must remain constant. B) price must decrease. C) nominal GDP must remain constant D) nominal GDP must double.

D) nominal GDP must double.

With the quantity theory of money equation, if the quantity of real money balances is k*Y, where k is a constant, then velocity is: A) k B) 1/р C) k*P D) none of the above.

D) none of the above. because rearranging the quantity theory of money equation, we have real balances = M / P = (1/V) * Y. We can identify 1/V as k. So k = 1 / V.

14. The one-to-one relation between the inflation rate and the nominal interest rate, the Fisher effect, assumes that the: A) money supply is constant. B) velocity is constant. C) inflation rate is constant. D) none of the above.

D) none of the above. since nominal rate = real rate + inflation rate, inflation rate has a one-to-one effect on nominal rate if the real rate is constant

16. In the classical model, together with the quantity theory of money equation and the Fisher equation/effect, an increase ni nominal money supply increases: A) the real interest rate. B) velocity C) the nominal interest rate. D) none of the above.

C) the nominal interest rate.

15. In the classical model, and according to the quantity theory of money, a 5percent increase in money growth increases inflation by _ percent. According to the Fisher equation a 5 percent increase in the rate of inflation increases the nominal interest rate by A) 1; 5 B) 5; 1 C) 1; 1 D) 5; :5

D) 5; :5 since in the classical model, Y is already determined/fixed at Y-bar and r is determined (already) in the goods market equilibrium equation. Given the above and the quantity theory of money equation, M is proportional to P (velocity is a constant in the quantity theory). And since the real rate, r is already determined or fixed, any increase in inflation rate translates to the same increase in nominal rate.

18. If the real return (real interest rate) on government bonds is 3 percent and the expected rate of inflation is 4 percent, then the cost of holding money is _______________ percent A) 1 B) 3 C) 4 D) 7

D) 7