Deck 17: Inflation

Question 1

The best definition of inflation is a(n):

A) decrease in the general price level.
B) increase in the price of one important commodity such as food.
C) persistent increase in the general level of prices as measured by a price index.
D) increase in the purchasing power of the dollar.

Answer 1

C

Question 2

As inflation drives up prices, people attempt to find substitutes and adjust what they buy. The resulting substitution bias problem causes the CPI to:

A) overstate the impact of higher prices on consumers.
B) consistently underestimate the true inflation rate.
C) omit the benefits of product quality improvements.
D) have larger fluctuations than other price indexes.

Answer 2

A

Question 3

Exhibit 7-1 Consumer Price Index

As shown in Exhibit 7-1, the rate of inflation for Year 2 is:

A) 5 percent.
B) 10 percent.
C) 20 percent.
D) 25 percent.

Answer 3

B

Question 4

Which of the following statements is true ?

A) Deflation is an increase in the general level of prices.
B) The consumer price index (CPI) measures changes in the average prices of consumer goods and services.
C) The real interest rate equals the nominal rate of interest plus the inflation rate.
D) Real income is the actual number of dollars received over a period of time.

Question 5

Suppose hypothetically that you buy a lot of food such as tofu, veggie burgers, and organic fruit that are not included in the market basket used to compute the CPI. In addition, suppose that all of these goods have become cheaper over the last year, while the overall CPI has increased by 6 percent. Then which of the following is true ?

A) The CPI will understate the negative impact of inflation on your purchasing power and standard of living.
B) The CPI will still accurately state the negative impact of inflation on your purchasing power and standard of living.
C) The CPI will overstate the negative impact of inflation on your purchasing power and standard of living.
D) Inflation has a larger effect on your standard of living than on the average consumer.

Question 6

Suppose that your income during Year X was $50,000, and the CPI for Year X was 150 (base year = Z=100). Back in Year Z your income was $30,000. Has your real income increased or decreased from Z to year X? By how much?

A) Increased by $5,000.
B) Increased by $3,333.
C) Decreased by $5,000.
D) Decreased by $3,333.

Question 7

Price indexes like the CPI are calculated using a base year. The term base year refers to:

A) the first year that price data are available.
B) any year in which inflation was higher than 5 percent.
C) the most recent year in which the business cycle hit the trough.
D) an arbitrarily chosen reference year.

Question 8

Suppose the price of banana rises over time and consumers respond by buying fewer bananas. This situation contributes to which bias in the consumer price index?

A) substitution bias
B) transportation bias
C) quality bias
D) indexing bias

Question 9

The salary of the president of the United States in 2000 was $400,000. In 1940, the president's salary was $75,000. If the Consumer Price Index was 8.1 in 1940 and 100 in 2000, the 1940 presidential salary measured in terms of the purchasing power of the dollar in 2000 would be:

A) less than $75,000.
B) less than $400,000.
C) approximately $668,850.
D) approximately $926,000.

Question 10

Consider an economy with only two goods: bread and wine. In 1982, the typical family bought 4 loaves of bread at 50¢ per loaf and 2 bottles of wine for $9 per bottle. In Year X, bread cost 75¢ per loaf and wine cost $10 per bottle. The CPI for Year X (using a 1982 base year) is:

A) 100.
B) 115.
C) 126.
D) 130.

Question 11

A reduction in the rate of inflation is called:

A) deflation.
B) disinflation.
C) hyperinflation.
D) cost-push inflation.

Question 12

As the price of gasoline rose during the 1970s, consumers cut back on their use of gasoline relative to other consumer goods. This situation contributed to which bias in the consumer price index?

A) substitution bias
B) transportation bias
C) quality bias
D) indexing bias

Question 13

Suppose a market basket of goods and services costs $1,000 in the base year and the consumer price index (CPI) is currently 110. This indicates the price of the market basket of goods and services is now:

A) $110.
B) $1,000.
C) $1,100.
D) $1,225.

Question 14

Suppose the consumer price index (CPI) for Year X is 130. This means the average price of goods and services is:

A) currently $130.
B) 130 percent more in Year X than in the base year.
C) 130 percent more in the base year than in Year X.
D) priced at 30 percent more in Year X than in the base year.

Question 15

Which of the following is the largest single component of the market basket used to compute the consumer price index (CPI)?

A) food and beverages
B) housing
C) transportation
D) medical care

Question 16

Exhibit 7-1 Consumer Price Index

As shown in Exhibit 7-1, the rate of inflation for Year 5 is:

A) 4.2 percent
B) 5 percent.
C) 20 percent.
D) 25 percent.

Question 17

If the consumer price index (CPI) in Year X was 300 and the CPI in Year Y was 325, the rate of inflation for Year Y was:

A) 325 percent.
B) 25 percent.
C) 5 percent.
D) 8 percent.

Question 18

One way the consumer price index (CPI) differs from the GDP chain price index is that the CPI:

A) uses current year quantities of goods and services.
B) includes separate market baskets of goods and services for both base and current years.
C) includes only goods and services bought by typical urban consumers.
D) is bias free.

Question 19

Suppose a market basket of goods and services costs $400 in the base year and the consumer price index (CPI) is currently 125. This indicates the price of the market basket of goods is now:

A) $275.
B) $425.
C) $500.
D) $525.

Question 20

Suppose we shopped for a basket of goods in Year 1 and it cost $350. Suppose the same basket of goods adds up to $385 in Year 2. If we use Year 1 as a base year, what would be the Year 2 CPI?

A) 35.
B) 90.
C) 100.
D) 110.

Question 21

Union contracts with built-in cost-of-living adjustments and home mortgages that vary with the rate of inflation are:

A) examples of failed policies of the 1970s.
B) examples of bracket creep.
C) means of implementing fiscal policy.
D) steps that can be taken to decrease the adverse impacts of inflation.

Question 22

If the nominal interest rate is 5 percent and there is no inflation, then the real interest rate:

A) exceeds 5 percent.
B) is less than 5 percent.
C) is 5 percent.
D) is zero.

Question 23

When the inflation rate rises, the purchasing power of nominal income:

A) remains unchanged.
B) decreases.
C) increases.
D) changes by the inflation rate minus one.

Question 24

How is inflation typically measured? What are the different types of inflation? Why is it important to know which type of inflation we may be experiencing?

Question 25

Last year the Olsen family earned $70,000. This year their income is $77,000. In an economy with an inflation rate of 8 percent, we can conclude that the Olsen's nominal income:

A) and real income both increased.
B) and real income both decreased.
C) increased, but their real income decreased.
D) decreased, but their real income increased.

Question 26

Tina Eckstrom and her husband bought a deferred annuity that started paying them $700 a month in retirement benefits. They, along with millions of other people who live on fixed incomes, are examples of:

A) those who are responsible for inflation.
B) the big winners from inflation.
C) the big losers from inflation.
D) the paradox of thrift.

Question 27

In periods of high inflation,

A) people want to hold on to as much money as possible.
B) the purchasing power of money is decreasing.
C) nobody wants to work and earn income.
D) low nominal interest rates are likely to result.

Question 28

Suppose your nominal income this year is 5 percent higher than last year. If the inflation rate for the period was 3 percent, then your real income was:

A) increased by 1.67 percent.
B) increased by 2 percent.
C) increased by 8 percent.
D) decreased by 0.6 percent.

Question 29

The real interest rate is defined as the:

A) actual interest rate.
B) fixed-rate on consumer loans.
C) nominal interest rate minus the inflation rate.
D) expected interest rate minus the inflation rate.

Question 30

What are some criticisms of the CPI as a measure of inflation?

Question 31

Assume that the real rate of interest is 5 percent and a lender charges a nominal interest rate of 15 percent. If a borrower expects that the rate of inflation next year will be 10 percent and the actual rate of inflation next year is 12 percent:

A) neither the borrower nor the lender benefits from inflation.
B) both the borrower and the lender lose from inflation.
C) the borrower benefits from inflation, while the lender loses from inflation.
D) the lender benefits from inflation, while the borrower loses from inflation.

Question 32

Suppose that last year you borrowed $100 at 5 percent interest to purchase a $100 pair of Nike cross-training shoes. This year you repaid the bank with interest. If the inflation rate was 10 percent last year, your purchase of the shoes would:

A) make you an inflation winner as you saved $5 on the shoes.
B) make you an inflation loser as you paid $5 more than you should have for the shoes.
C) not be affected at all by the inflation rate.
D) be taxed according to COLA adjustments.

Question 33

A worker would be hurt least by inflation when the:

A) worker anticipates inflation and increases savings at the bank.
B) worker is protected by a cost-of-living adjustment clause in an employment contract.
C) price level increases but at a decreasing rate.
D) worker is protected by fixed annual increases in wages and benefits in an employment contract.

Question 34

Last year the Jones family earned $40,000. This year their income is $42,000. In an economy with an inflation rate of 10 percent, which of the following is correct?

A) The Jones' nominal income and real income have both fallen.
B) The Jones' nominal income and real income have both risen.
C) The Jones' nominal income has increased and their real income has fallen.
D) The Jones' nominal income has decreased and their real income has risen.

Question 35

The CPI (using a 2000 base year) for 1965 is 26.0. Suppose a household's annual take-home pay in 1965 was $8,320. What would be an equivalent take-home pay in 2000?

A) $10,483.
B) $21,632.
C) $23,680.
D) $32,000.

Question 36

Suppose you received a 5 percent increase in your nominal wage. Over the year, inflation ran about 2 percent. Which of the following is true ?

A) Your real wage increased.
B) Your nominal wage decreased.
C) Both your nominal and real wages decreased.
D) Although your nominal wage rose, your real wage decreased.

Question 37

During periods of hyperinflation, which of the following is the most likely response of consumers?

A) Save as much as possible.
B) Spend money as fast as possible.
C) Invest as much as possible.
D) Lend money.

Question 38

Which of the following is true about inflation?

A) Inflation promotes social harmony by uniting people against the government.
B) Inflation is more damaging if it is anticipated.
C) Accurate anticipation of inflation is possible for everyone who is well informed about economic events.
D) Those who lend money at a rate below the rate of inflation suffer economic losses.

Question 39

Losers from inflation include:

A) those on a fixed income and savers.
B) landlords and the government.
C) borrowers and the government.
D) those on a fixed income and borrowers.

Question 40

Real income for a given year would be less than nominal income in that year if:

A) the consumer price index was less than 100 in that year.
B) nominal income in that year was greater than nominal income in the previous year.
C) nominal income in that year was less than nominal income in the previous year.
D) the consumer price index was greater than 100 in that year.

Question 41

Which of the following is not a cause of cost-push inflation?

A) labor cost increases.
B) energy cost increases.
C) raw material cost increases.
D) consumer incomes increase.

Question 42

Demand-pull inflation is due to:

A) minimum wage laws.
B) labor cost increases.
C) excess total spending.
D) tax increase.

Question 43

Assume that the real rate of interest is 5 percent and a lender charges a nominal interest rate of 15 percent. If a borrower expects that the rate of inflation next year will be 10 percent and the actual rate of inflation next year is 10 percent,

A) the lender benefits from inflation, while the borrower loses from inflation.
B) the borrower benefits from inflation, while the lender loses from inflation.
C) neither the borrower nor the lender benefits from inflation.
D) both the borrower and the lender lose from inflation.

Question 44

Cost-push inflation occurs:

A) at or close to full employment.
B) because of excess total spending.
C) when "too much money is chasing too few goods."
D) when there are increases in production costs.

Question 45

Hyperinflation refers to a situation in which:

A) prices are rising extremely rapidly.
B) prices are falling extremely rapidly.
C) the price level is extremely high.
D) the price level is extremely low.

Question 46

When OPEC raised the price of oil, it created a:

A) demand-pull inflation.
B) cost-push inflation.
C) demand-push inflation.
D) cost-pull inflation.

Question 47

Demand-pull inflation is associated with:

A) decreasing total spending (demand).
B) increasing total spending (demand).
C) decreasing costs of production (supply).
D) increasing costs of production (supply).

Question 48

The likely result of an economy operating at full employment is:

A) cost-push inflation.
B) demand-pull inflation.
C) a lower rate of growth.
D) hyperinflation.

Question 49

Which of the following statements is true ?

A) Demand-pull inflation is caused by insufficient total spending.
B) Cost-push inflation is caused by an increase in resource costs.
C) If nominal interest rates remain the same and the inflation rate rises, real interest rates increase.
D) If real interest rates are positive, lenders incur losses.

Question 50

Consider borrowers and lenders who agree to loans with fixed nominal interest rates. If inflation is higher than what the borrowers and lenders expected, then who benefits from lower real interest rates?

A) Only the borrowers benefit.
B) Only the lenders benefit.
C) Both borrowers and lenders benefit.
D) Neither borrowers nor lenders.

Question 51

Cost-push inflation is due to:

A) "too much money chasing too few goods".
B) the economy operating at full employment.
C) increases in production costs.
D) excess total spending.

Question 52

A dramatic and sustained increase in oil prices would most likely:

A) increase demand-pull inflation.
B) decrease demand-pull inflation.
C) increase cost-push inflation.
D) decrease cost-push inflation.

Question 53

Which of the following can create demand-pull inflation?

A) Excessive aggregate spending.
B) Sharply rising oil prices.
C) Higher labor costs.
D) Recessions and depressions.

Question 54

Who is hurt and who benefits from inflation? Why?

Question 55

Suppose you place $10,000 in a retirement fund that earns a nominal interest rate of 8 percent. If you expect inflation to be 5 percent or lower, then you are expecting to earn a real interest rate of at least:

A) 1.6 percent.
B) 3 percent.
C) 4 percent.
D) 5 percent.

Question 56

Suppose the Organization of Petroleum Exporting Countries (OPEC) sharply increased the price of oil, which triggered higher inflation rates in the United States. This type of inflation is best classified as:

A) pseudo-inflation.
B) demand-pull inflation.
C) cost-push inflation.
D) hyperinflation.