Chapter 22 Inflation

*Ch22 Inflation*

*Multiple Choice Questions*

*1. *__________ implies that pressure for price increases reaches across _______________markets, not just one.

A. inflation; all
B. deflation; most
C. inflation; most
D. deflation; all

Explanation:

Type: Multiple Choice

*2. *While one occasionally sees references to inflation over short time periods, the term typically implies a(n)_____________ in prices.

A. ongoing decrease
B. ongoing rise
C. short term rise
D. short term decrease

Explanation:

Type: Multiple Choice

*3. *The effects of inflation are seen in:

A. goods and services only
B. wages and income levels only
C. services and wages only
D. goods, services, wages and income levels

Explanation:

Type: Multiple Choice

*4. *Inflation implies that the level of all prices _____________________.

A. decrease
B. stay the same
C. increase
D. none of the above

Explanation:

Type: Multiple Choice

*5. *When Anders took out his first two-year membership with Maxima Gym in 2004, the fee was \$540.00. He renewed his membership three times; in 2006 for \$580.00, in 2008, for \$600.00, and again in 2010, for \$630.00. What is the overall rate of inflation for Anders’ gym membership?

A. 8.6%
B. 5.4%
C. 7.87%
D. 16.66%

Explanation:

Type: Multiple Choice

*6. *Inflation can be calculated in terms of how the overall cost of ___________________ changes over time.

A. all goods
B. the basket of goods
C. all goods and services
D. all services

Explanation:

Type: Multiple Choice

*7. *If the price index moves from 107 to 110, the rate of inflation is:

A. 3%
B. 30%
C. 28%
D. 2.8%

Explanation:

Type: Multiple Choice

*8. *The most commonly cited measure of inflation in the United States is:

A. the Consumer Price Index (CPI).
B. the Deflationary Price Index (DPI)
C. the Cumulative Price Index (CPI)
D. the Inflationary Price Index (IPI)

Explanation:

Type: Multiple Choice

*9. *One of the reasons that a rise in the price of a fixed basket of goods over time tends to overstate the rise in a consumer’s true cost of living, is:

A. substitution bias
C. complimentary bias
D. preference bias

Explanation:

Type: Multiple Choice

*10. *The percentage change in the price level from one time period to the next, whether the price level is measured in terms of money or as a price index, will be the _____________.

A. inflation rate
B. price index rate
C. consumer price index
D. producer price Index

Explanation:

Type: Multiple Choice

*11. *The basket of goods in the Consumer Price Index consists of about _________ products; that is, several hundred specific products in over __________ broad-item categories.

A. 200; 800
B. 80,000; 400
C. 80,000; 200
D. 800; 200

Explanation:

Type: Multiple Choice

*12. *Two factors that complicate the calculation of the inflation rate are:

A. substitution and quality/new product bias
B. preferential bias
C. complimentary product bias
D. consumer behavior bias

Explanation:

Type: Multiple Choice

*13. *When we want to measure wage inflation in the labor market, we use the:

A. Consumer Price Index
B. Product Price Index
C. Employment Cost Index
D. Employment Price Index

Explanation:

Type: Multiple Choice

*14. *The Producer Price Index is based on prices paid for supplies and inputs by:

A. consumers
B. producers of goods and services
C. government
D. the small business sector

Explanation:

Type: Multiple Choice

*15. *The ____________________ is based on the prices of merchandise that are exported or imported.

A. International Product Index
B. Producer Price Index
C. Foreign Price Index
D. International Price Index

Explanation:

Type: Multiple Choice

*16. *Another term used to describe negative inflation is:

A. counter inflation
B. deflation
C. hyperinflation
D. GDP deflator

Explanation:

Type: Multiple Choice

*17. *In the early 1990’s extremely high inflation rates of 2500% were common in Russia. During that time, we can say that as a result of those inflation rates, Russia was experiencing ___________________.

A. perpetual inflation
B. ultra inflation
C. hypo inflation
D. hyperinflation

Explanation:

Type: Multiple Choice

*18. *Which of the following is an example of one of the major categories in the overall CPI?

A. apparel and accessories
B. entertainment
C. recreation
D. transportation and insurance

Explanation:

Type: Multiple Choice

*19. *The situation where the buying power of money in terms of goods and services increases is called:

A. deflation.
B. inflation.
C. stationary pricing.
D. hyperinflation.

Explanation:

Type: Multiple Choice

*20. *Which of the following is the name used to describe the price index that consists of intermediate goods and finished goods?

A. Producer Price Index
B. Consumer Price Index
C. Employment Cost Index
D. Processing Price Index

Explanation:

Type: Multiple Choice

*21. *What name is given to the index based on the prices of exported or imported merchandise?

A. U.S. Producer Trade Index
B. International Trade Index
C. International Price Index
D. U.S. Producer Price Index

Explanation:

Type: Multiple Choice

*22. *An economics professor is discussing a measure of inflation over time based on a basket of goods comprised of all the components of GDP. Which measure is it?

A. Consumer Price Index
B. GDP Price Index
C. Consumer GDP
D. GDP Deflator

Explanation:

Type: Multiple Choice

*23. *The GDP deflator is a price index that includes the following components of GDP:

A. Consumption
B. Consumption plus Investment but not Exports
C. Consumption, Investment plus Exports minus Imports
D. Consumption, Investment, Government plus Exports minus Imports

Explanation:

Type: Multiple Choice

*24. *With regard to the economy, the term negative inflation is synonymous with which of the following?

A. recession
B. depression
C. deflation
D. hyperinflation

Explanation:

Type: Multiple Choice

*25. *An analyst needs to adjust the nominal GDP for the years 2000 and 2010 into real terms to conclude his comparison analysis. The nominal GDP in 2000 was \$672 billion and \$1,690 billion for 2010; the real interest rate was 6.79% in 2000 and 3.71% in 2010; the 2000 deflator was 24 and 51 in 2010. What is the real gain?

A. 18.34%
B. 38.58%
C. 151.48%
D. 70.61%

Explanation:

Type: Multiple Choice

*26. *Alex wants to measure the nominal 1998 GDP of \$993 billion in 2008 dollars. From the data he gathered, he knows the deflator for 1998 is 30 and for 2008, it is 74, and that real interest in those years was 6.23% and 3.21% respectively. If he avoids making a misleading calculation, what will the value be?

A. \$430 billion
B. \$835 billion
C. \$2,063 billion
D. \$2,449 billion

Explanation:

Type: Multiple Choice

*27. *What distinguishes the real value of a statistic from the nominal value of a statistic?

A. timing of announcement
B. adjusting for inflation
C. adjusting for GDP deflator
D. real interest rate

Explanation:

Type: Multiple Choice

*28. *Nancy’s union has negotiated a three-year wage contract that provides for a 2.4% increase indexed to inflation. The rates of inflation are forecast to be 1.62%, 1.93% and 2.21% respectively. How will Nancy’s wage increase be expressed in the new contract?

A. COLA plus 1.6%
B. COLA plus 1.9%
C. COLA plus 2.4%
D. COLA plus 2.2%

Explanation:

Type: Multiple Choice

*29. *When a price, wage, or interest rate is adjusted automatically with inflation, it is said to be __________.

A. indexed
B. COLAed
D. semi-indexed

Explanation:

Type: Multiple Choice

*30. *In the 1970s and 1980s, labor unions commonly negotiated wage contracts that had _______________________ which guaranteed that their wages would keep up with inflation.

A. cost of living adjustments
B. inflation protection plans
C. inflation ceiling guarantees
D. wage protection clauses

Explanation:

Type: Multiple Choice

*31. *The effect of substitution bias is that the rise in the price of a fixed basket of goods over time tends to ___________________ the rise in a consumer’s true cost of living, because it doesn’t take into account that the person can substitute between goods according to changes in their relative prices.

A. stabilize
B. understate
C. overstate
D. reduce

Explanation:

Type: Multiple Choice

*32. *The __________________ is the nominal interest rate minus the rate of inflation.

A. real GDP
B. real interest rate
D. annualized interest rate

Explanation:

Type: Multiple Choice

*33. *A payment is said to be ________________ if it is automatically adjusted for inflation.

A. cross referenced
B. indexed
C. matched
D. maintained

Explanation:

Type: Multiple Choice

*34.* A lender demands an interest rate in part to compensate for any expected ___________, so that the money that is repaid in the future will have at least as much buying power as the money that was originally loaned.

B. inflation
C. compound interest
D. opportunity costs

Explanation:

Type: Multiple Choice

*Essay Questions*

*1. *Identify and contrast the differences between the rise in prices due to inflation and the rise in prices in microeconomic markets.

The first difference is that price changes in the microeconomic supply-and-demand model refer to a price in a particular market. Inflation implies that pressure for price increases reaches across most markets, not just one.

The second difference is that price increases in the supply-and-demand model were one-time events, representing a shift from a previous equilibrium to a new one. Inflation over short time periods may happen occasionally, but the term typically implies an ongoing rise in prices.

Reference:

Explanation:

Type: Essay

*2. *Describe the formula used to calculate the annual rate of inflation.

Level in new year – level in original year x 100 = percentage change
___________________________________________
(level in original year)

Reference:

Explanation:

Type: Essay

*3. *Explain why statisticians use index numbers to calculate the rate of inflation. Describe the formula for the calculation.

Statisticians use index numbers as substitutes for dollar amounts to simplify the task of interpreting the price levels for more realistic and complex baskets of goods.

Total amount spent in base year = Total amount spent in other year
__________________________________ ___________________________________
Index number in base year, always 100 Index number in other year

Reference:

Explanation:

Type: Essay

*4. *Identify the most commonly cited measure of inflation in the United States and explain how it is calculated. Identify and briefly discuss the subtle problem that statisticians have paid considerable attention to in recent years.

The most commonly cited measure of inflation in the United States is the Consumer Price Index (CPI). The CPI is calculated by government statisticians at the U.S. Bureau of Labor Statistics based on the price level based on a basket of goods and services that represents the purchases of the average consumer.

In recent years, the statisticians at the Bureau of Labor Statistics have paid considerable attention to the subtle problem that measuring how the total cost of buying a fixed basket of goods has evolved over time is conceptually not quite the same as measuring a change in the cost of living, which represents how much it costs for a person to feel that their consumption provides an equal level of satisfaction or utility.

Reference:

Explanation:

Type: Essay

*5. *Identify and briefly describe the problems that always arise from measuring price levels with a fixed basket of goods and what steps can be taken to counter these problems.

Measuring price levels with a fixed basket of goods will always have two problems, namely substitution bias and quality/new goods bias.

The substitution bias, arises when using a fixed basket of goods because it does not allow for buying more of what is relatively less expensive and less of what is relatively more expensive.

The quality/new goods bias arises when using a fixed basket because doing so cannot take into account improvements in quality and the advent of new goods.

Both of these problems can be reduced in degree—for example, by allowing the basket of goods to evolve over time—but they cannot be totally eliminated.

Reference:

Explanation:

Type: Essay

*6. *Contrast the influence of inflation with the influence of deflation with respect to the buying power of money in terms of goods and services.

Inflation is a time when the buying power of money in terms of goods and services is reduced. Deflation is a time when the buying power of money in terms of goods and services increases.

Reference:

Explanation:

Type: Essay

*7. *Russia experienced inflation of 2500% per year in the early 1990s. Identify the term used to describe this extreme level of inflation rate and briefly discuss the contributing economic factors that caused this situation to arise.

Historically, Russia had a controlled economy with very low rates of measured inflation because prices were forbidden to rise by law. During those times, the Russian population also had perpetual shortages of goods, because forbidding prices to rise acted like a price ceiling and created a situation where the quantity of goods demanded often exceeded the quantity supplied. As Russia made a transition toward a more market-oriented economy in the 1990s, the price ceilings were eliminated and as a consequence the economy experienced an outburst of extreme inflation, known as hyperinflation before settling in time to a more reasonable rate of inflation at less than 10%.

Reference:

Explanation:

Type: Essay

*8. *Describe the relationship between inflation levels in prices and inflation levels for prices, wages and interest rates with respect to their ability to affect people’s economic status and business outcomes.

If all prices, wages, and interest rates adjusted automatically and immediately with inflation, then no one’s purchasing power or profits or real loan payments would change. However, if other economic variables do not move exactly in sync with inflation, or if they adjust for inflation only after a time lag, then inflation can cause three types of problems: unintended redistributions of purchasing power, blurred price signals, and difficulties in long-term planning.

Reference:

Explanation:

Type: Essay

*9. *In 1996 the U.S. government began offering indexed bonds. Contrast the use of traditional government bonds with government indexed bonds. Include a brief explanation of the benefits of each form of bond and identify the party that received that benefit.

Traditionally, government bonds have paid a fixed rate of interest. This policy gave a government that had borrowed an incentive to encourage inflation, because it could then repay its past borrowing in inflated dollars at a lower real interest rate.

Indexed government bonds promise to pay a certain real rate of interest above whatever inflation rate occurs. A retiree trying to plan for the long term and worried about the risk of inflation, will benefit by purchasing indexed government bonds which guarantee a rate of return higher than inflation no matter the level of inflation.

Reference:

Explanation:

Type: Essay

*10. *Compare the different measures of inflation known as GDP deflator, the Producer Price Index and explain how to calculate the real interest rate.

The GDP deflator is based on a basket of goods representing everything in GDP. The Producer Price Index is based on a basket of goods representing supplies and inputs bought by producers of goods and services. The real interest rate is calculated by subtracting the rate of inflation from the nominal interest.

Reference:

Explanation:

Type: Essay

*11.* Why does \$100 in the future not have the same value as \$100 today?

Reference:

Explanation: Even if you knew with complete certainty that the \$100 will be repaid in the future, and even if the rate of inflation is zero, it is still annoying to wait several years for repayment. If you have the money now, you can spend it on something now if you wish to do so and receive benefits from that spending. Being forced to wait is an intangible cost, but still a cost. This cost of having to wait is referred to as the time value of money.

Type: Essay

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