EC102: CLASS 5 LTChristina Ammon

Quiz Question 1

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.

Essay 5 Question c

Describe the two main measures of inflation

1. Percentage change in Consumer Price Index • value of a fixed basket of goods at a certain date • measures the “cost of living • Measures price changes weighted by importance of goods in budget• Doesn’t measure changes different compositions of baskets

2. Percentage change in the GDP Deflator. • Nominal GDP/Real GDP *100• Nominal GDP - current prices, Real GDP - base year prices• Does not include imported goods

Essay 5 Question d

Inflation interferes with the market allocation mechanism. Explain.

1. Prices change due to other reasons but preferences• Makes it hard to distinguish overall from relative price changes

2. Prices are sticky• Creates relative price changes if not all firms are able to adjust prices at

the same speed

Quiz Question 2

In the case of an unanticipated inflation: A. creditors with an unindexed contract are hurt because they

get less than they expected in real terms.  B. creditors with an indexed contract gain because they get

more than they contracted for in nominal terms.  C. debtors with an unindexed contract do not gain because

they pay exactly what they contracted for in nominal terms.  D. debtors with an indexed contract are hurt because they pay

more than they contracted for in nominal terms.

Quiz Question 3

If inflation is 6 percent and a worker receives a 4 percent wage increase, then the worker's real wage:

A. increased 4 percent.  B. increased 2 percent.  C. decreased 2 percent.  D. decreased 6 percent.

Essay 4 Question a

Faced with a negative demand shock, the central bank needs to strike a balance between doing “too much” and doing “too little”. Explain.

Central bank faces trade-off between increasing output and decreasing inflation

Can work as demand shock itself If too much – output surpasses natural rate - generates

inflation If too little – output stays low = recession

Essay 5 Question c

When will a monetary expansion not result in inflation?

Essay 5 Question f

Explain why disinflation is costly.

What is disinflation? What is deflation?

Depends on expectations If unexpected disinflation• Whenever inflation is lower than expectations• Prices increase more than money supply• Real Money Balances fall• Equivalent of a demand shock

What happens if disinflation is expected?

Essay 5 Question g

In ending a hyperinflation, it is useful to have a “nominal anchor”. Explain.

Quiz Question 4

In practice, in order to stop a hyperinflation, in addition to stopping monetary growth, the government must:

A. lower taxes and raise government spending. B. raise taxes and reduce government spending.  C. change from one kind of currency to another.  D. call for a new election.

Question 4

If a central bank drops money from a helicopter• It won’t affect interest rates as there is no corresponding purchase of

bonds• It will have the same effects as an OMO for the same amount• Will affect demand positively through lower interest rates and

negatively through inflation• Combines elements of monetary and fiscal stimulus