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Chapter 32 Summary http://www.mhhe.com/economics/samuelson17/students/summ32.mhtml A. Nature and Impacts of Inflation 1. Recall that inflation occurs when the general level of prices is rising. The rate of inflation is the percentage change in a price index from one period to the next. The major price indexes are the consumer price index (CPI) and the GDP deflator. 2. Like diseases, inflations come in different strains. We generally see low inflation in the United States (a few percentage points annually). Sometimes, galloping inflation produces price rises of 50 or 100 or 200 percent each year. Hyperinflation takes over when the printing presses spew out currency and prices start rising many times each month. Historically, hyperinflations have almost always been associated with war and revolution. 3. Inflation affects the economy by redistributing income and wealth and by impairing efficiency. Unanticipated inflation usually favors debtors, profit seekers, and risk-taking speculators. It hurts creditors, fixed-income classes, and timid investors. Inflation leads to distortions in relative prices, tax rates, and real interest rates. People take more trips to the bank, taxes may creep up, and measured income may become distorted. And when central banks take steps to lower inflation, the real costs of such steps in terms of lower output and employment can be painful. B. Modern Inflation Theory 4. At any time, an economy has a given inertial or expected inflation rate. This is the rate that people have come to anticipate and that is built into labor contracts and other agreements. The inertial rate of inflation is a short-run equilibrium and persists until the economy is shocked. 5. In reality, the economy receives incessant price shocks. The major kinds of shocks that propel inflation away from its inertial rate are demand-pull and cost-push. Demand-pull inflation results from too much spending chasing too few goods, causing the aggregate demand curve to shift up and to the right. Wages and prices are then bid up in markets. Cost-push inflation is a new phenomenon of modern industrial economies and occurs when the costs of production rise even in periods of high unemployment and idle capacity. 6. The Phillips curve shows the relationship between inflation and unemployment. In the short run, lowering one rate means raising the other. But the short-run Phillips curve tends to shift over time as expected inflation and other factors change. If policymakers attempt to hold unemployment below the NAIRU for long periods, inflation will tend to spiral upward. 7. Modern inflation theory relies on the concept of the nonaccelerating inflation rate of unemployment, or NAIRU, which is the lowest NAIRU that the nation can enjoy without risking an upward spiral of inflation. It represents the level of unemployment of resources at which labor and product markets are in inflationary balance. Under the NAIRU theory, there is no permanent tradeoff between unemployment and inflation, and the long-run Phillips curve is vertical. C. Dilemmas of Anti-inflation Policy 8. A central concern for policymakers is the cost of reducing inertial inflation. Current estimates indicate that a substantial recession is necessary to slow inertial inflation. 9. Economists have put forth many proposals for lowering the NAIRU; notable proposals include improving labor market information, improving education and training programs, and refashioning government programs so that workers have greater incentives to work. Sober analysis of politically viable proposals leads most economists to expect only small improvements from such labor market reforms. 10. Because of the high costs of reducing inflation through recessions, nations have often looked for other approaches. These are incomes policies such as wage-price controls and voluntary guidelines, tax-based approaches, and market-strengthening strategies. CONCEPTS FOR REVIEW History and Inflation(t) = [P(t) strains of inflation: - Theories P(t - of 1)]/P(t - 1) Inflation × 100 low galloping hyperinflation impacts of inflation anticipated inflation costs of inflation: "shoe menu income loss of information (redistributive, and and on output tax and employment) unanticipated leather" costs distortions inertial, demand-pull, and cost-push inflation short-run and long-run Phillips curves nonaccelerating inflation rate of unemployment (NAIRU) and the long-run Phillips curve Anti-inflation costs of Policy disinflation measures to alternative anti-inflation policies: incomes competition TIP profit sharing lower the NAIRU policies Chapter 32 Preliminary Quiz http://www.mhhe.com/economics/samuelson17/students/quiz32pre.mhtml Ensuring Price Stability Multiple Choice Questions: Enter your answer to each of the questions in the blank to the left of the question. Be sure to use lowercase letters only! 1. When the general level of prices is rising, we call that: a. deflation. b. inflation. c. elevation. d. none of the above. 2. When prices rise slowly and predictably, we call that: a. galloping inflation. b. low inflation. c. hyperinflation. d. deflation. 3. When inflation is in the double or triple digits, we call that: a. galloping inflation. b. low inflation. c. hyperinflation. d. deflation. 4. When inflation is at a million or trillion percent per year, we call that: a. galloping inflation. b. low inflation. c. hyperinflation. d. deflation. 5. In general, unanticipated inflation will be good for: a. debtors. b. creditors. c. lenders. d. none of the above. 6. Hyperinflations are associated with ______ growth, low inflation is associated with _______ growth, and deflations are associated with _______ growth. a. rapid; rapid; negative b. negative; rapid; rapid c. negative; rapid; slow d. slow; rapid; negative. 7. Demand-pull inflation occurs when: a. imports exceed exports. b. aggregate demand rises more rapidly than the economy's productive potential. c. both a and b. d. neither a nor b. 8. Inflation resulting from rising costs during periods of high unemployment and slack resource utilization is called: a. demand-pull inflation. b. supply-pull inflation. c. cost-pull inflation. d. inertial inflation. 9. _______ occurs when the AS and AD curves are moving steadily upward at the same rate. a. demand-pull inflation. b. supply-pull inflation. c. cost-pull inflation. d. inertial inflation. 10. The short-run _______ shows the inverse relationship between inflation and unemployment. a. aggregate supply curve b. aggregate demand curve c. Phillips Curve d. NAIRU 11. The unemployment rate consistent with a constant inflation rate is called: a. NAIRU b. hyperinflation c. Phillips rate d. none of the above. 12. The long-run Phillips curve: a. is horizontal at the NAIRU. b. is vertical at the NAIRU. c. is fixed at the origin. d. does not exist. Grade the Quiz Chapter 32 Preliminary Quiz Grade Question Your Answer Grade Correct Answer 1. incorrect b. When the general level of prices is rising, we call that inflation. See page 683. 2. incorrect b. When prices rise slowly and predictably, we call that low inflation. See page 685. 3. incorrect a. When inflation is in the double or triple digits, we call that galloping inflation. See page 687. 4. incorrect c. When inflation is at a million or trillion percent per year, we call that hyperinflation. See page 687. 5. incorrect a. In general, unanticipated inflation will be good for debtors. See page 689. 6. incorrect c. Hyperinflations are associated with negative growth, low inflation is associated with rapid growth, and deflations are associated with slow growth. See page 690. 7. incorrect b. Demand-pull inflation occurs when aggregate demand rises more rapidly than the economy's productive potential. See page 692. 8. incorrect c. Inflation resulting from rising costs during periods of high unemployment and slack resource utilization is called cost-pull inflation. See page 692. 9. incorrect d. Inertial inflation occurs when the AS and AD curves are moving steadily upward at the same rate. See page 693. 10. incorrect c. The short-run Phillips Curve shows the inverse relationship between inflation and unemployment. See page 695. 11. incorrect a. The NAIRU is the unemployment rate consistent with a constant inflation rate. See page 696. 12. incorrect b. The long-run Phillips curve is vertical at the NAIRU. See page 698. Click to return to Quiz Index Chapter 32 Post Quiz http://www.mhhe.com/economics/samuelson17/students/quiz32post.mhtml Ensuring Price Stability Matching Questions: Match the terms on the left with the definition in the column on the right. Enter the lowercase letter of that definition in the box to the left of the question number. 1. Inflation a. gain from unanticipated inflation. 2. Low inflation b. when prices rise slowly and predictably. 3. Galloping inflation c. occurs when aggregate demand rises more rapidly then the economy's productive potential. 4. Hyperinflation d. when inflation is in the double or triple digits. 5. Debtors e. results from rising costs during periods of high unemployment and slack resource utilization. 6. Negative growth f. associated with hyperinflation. 7. Demand-pull inflation g. when inflation is at a million or trillion percent per year. 8. Cost-pull inflation h. occurs when the AS and AD curves are moving steadily upward at the same rate. 9. Inertial inflation i. the unemployment rate consistent with a constant inflation rate. 10. Phillips curve j. when the general level of prices is rising. 11. NAIRU k. shows the inverse relationship between inflation and unemployment. 12. Vertical l. describes the long-run Phillips curve. Grade the Quiz Chapter 32 Post Quiz Grade Question Your Answer Grade Correct Answer 1. incorrect j. Inflation is when the general level of prices is rising. See page. 683. 2. incorrect b. When prices rise slowly and predictably, we call that low inflation. See page 685. 3. incorrect d. When inflation is in the double or triple digits, we call that galloping inflation. See page 687. 4. incorrect g. When inflation is at a million or trillion percent per year, we call that hyperinflation. See page 687. 5. incorrect a. Debtors gain from unanticipated inflation. See page 689. 6. incorrect f. Negative growth is associated hyperinflation. See page 690. 7. incorrect c. Demand-pull inflation occurs when aggregate demand rises more rapidly then the economy's productive potential. See page 692. 8. incorrect e. Cost-pull inflation results from rising costs during periods of high unemployment and slack resource utilization. See page 692. 9. incorrect h. Inertial inflation occurs when the AS and AD curves are moving steadily upward at the same rate. See page 693. 10. incorrect k. The Phillips curve shows the inverse relationship between inflation and unemployment. See page 695. 11. incorrect i. The NAIRU is the unemployment rate consistent with a constant inflation rate. See page 696. 12. incorrect l. The long-run Phillips curve is vertical. See page 698. Click to return to Quiz Index with