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Chapter 7: Inflation
Chapter 7: Inflation
Multiple Choice Questions
WHAT IS INFLATION?
1. Inflation rates above 10 percent rarely occur:
A) In the world today.
B) In the United States.
C) During wartime periods.
D) In or during all of the above.
Answer: B Type: Basic Understanding Page: 130
2. An increase in the average level of prices of goods and services is:
A) Deflation. B) Recession. C) Depression. D) Inflation.
Answer: D Type: Definition Page: 130
3. Which of the following is true about a period of inflation?
A) Prices of all goods stay the same or are rising.
C) The average price level is rising.
B) All prices are rising.
D) All of the above.
Answer: C Type: Definition Page: 130
4. Inflation me
A) Specific prices are rising, and relative prices are falling.
B) Both relative prices and average prices are rising.
C) Relative prices are rising, but it is not certain what is happening to average prices.
D) Average prices are rising, but it is not certain what is happening to relative prices.
Answer: D Type: Definition Page: 130
5. A decrease in the average level of prices of goods and services is:
A) Deflation. B) Recession. C) Depression. D) Inflation.
Answer: A Type: Definition Page: 130
6. When there is no deflation or inflation:
A) Prices of all goods change by the same percentage.
B) Relative prices remain unchanged.
C) Average prices rise by zero percent.
D) Full employment is achieved.
Answer: C Type: Definition Page: 130
Page 1
Chapter 7: Inflation
Use the following to answer questions 7-10:
PERCENTAGE CHANGE IN CONSUMER PRICE INDEX
Figure 7.1
8
6
4
2
Country B
0
Country A
-2
-4
1970
1975
1980
1985
1990
1995
YEAR
7. According to Figure 7.1 in Country A:
A) Relative prices may be changing but average prices are constant.
B) Relative prices are definitely constant.
C) Average prices and relative prices are definitely changing.
D) Average prices are constant and unemployment is increasing.
Answer: A Type: Complex Understanding Page: 130
8. According to Figure 7.1, which of the following statements is definitely true about Country B?
A) Relative prices are changing.
C) Real incomes are decreasing.
B) Average price levels are changing.
D) Relative prices are constant.
Answer: B Type: Complex Understanding Page: 130
9. According to Figure 7.1, which of the following statements is definitely true about Country A?
A) Real incomes are changing.
B) Relative prices are not changing.
C) There are no redistributive effects on income and wealth from inflation.
D) All of the above are true.
Answer: C Type: Complex Understanding Page: 130
10. During the time period represented in Figure 7.1, Country A:
A) Experienced periods of both inflation and deflation.
B) Never achieved the inflation goal set by the Full Employment and Balanced Growth Act of 1978.
C) Had no need for COLAs.
D) Experienced only inflation.
Answer: C Type: Complex Understanding Page: 130
Page 2
Chapter 7: Inflation
Use the following to answer questions 11-12:
PERCENTAGE CHANGE IN CONSUMER PRICE INDEX
Figure 7.2
8
6
4
2
0
Country B
-2
Country A
-4
1970
1975
1980
1985
1990
1995
YEAR
11. According to Figure 7.2, Country B:
A) Had less inflation each year than Country A.
B) Had less inflation than Country A on average but had a higher level of unemployment.
C) Experienced periods of both inflation and deflation.
D) Had an inflation rate of 4 percent per year.
Answer: C Type: Complex Understanding Page: 130
12. Which of the following statements is true about the two countries represented in Figure 7.2 in the year 1995?
A) The countries had approximately the same rate of inflation.
B) The countries had approximately the same CPI (assuming 1970 was the base year).
C) The average price level was approximately the same.
D) All of the above are true.
Answer: A Type: Analytical Page: 130
13. Changes in relative prices may occur in a period of:
A) Stable prices. B) Inflation. C) Deflation. D) All of the above.
Answer: D Type: Basic Understanding Page: 130
Page 3
Chapter 7: Inflation
14. Changes in the relative prices of two goods indicate:
A) Inflation.
B) Nominal price changes adjusted for the inflation in the price of the goods.
C) That average prices for the period must not be stable.
D) Changes in the desired mix of output.
Answer: D Type: Definition Page: 130
15. Which of the following functions are performed by changes in relative prices but not by changes in average
prices?
A) Computing real income from nominal income. C) Signaling changes in the desired mix of output.
B) Indicating an overheating economy.
D) Measuring the rates of inflation.
Answer: C Type: Basic Understanding Page: 130
16. If the price of computers falls 6 percent during a period when the level of average prices falls 12 percent, the
relative price of computers compared with other goods:
A) Stays the same. B) Increases. C) Decreases. D) More information is required.
Answer: B Type: Definition Page: 130
17. If the price of health services rises 13 percent during a period when the level of average prices rises 13
percent, the relative price of health services compared with other goods and services:
A) Stays the same. B) Increases. C) Decreases. D) More information is required.
Answer: A Type: Definition Page: 130
18. If the price of computers falls 12 percent during a period when the level of average prices falls 6 percent, the
relative price of computers:
A) Stays the same. B) Increases. C) Decreases. D) More information is required.
Answer: C Type: Basic Understanding Page: 130
19. When the price of a good decreases more slowly than an index of average prices decreases, then the good's
relative price:
A) Has risen while its absolute price has fallen.
C) And absolute price have fallen.
B) And absolute price have risen.
D) Has fallen while its absolute price has risen.
Answer: A Type: Basic Understanding Page: 130
20. When the price of a good is increasing more slowly than an index of average prices, then generally the good's
relative price:
A) Has risen while its absolute price has fallen.
C) And absolute price have fallen.
B) And absolute price have risen.
D) Has fallen while its absolute price has risen.
Answer: D Type: Basic Understanding Page: 130
Page 4
Chapter 7: Inflation
21. Comparing relative prices is more useful than examining average prices in:
A) Determining the redistribution of income as a result of inflation.
B) Determining the inflation rate.
C) Deflating nominal income.
D) All of the above.
Answer: A Type: Basic Understanding Page: 130
RESTRIBUTIVE EFFECTS OF INFLATION
22. Which of the following explains why destributin occurs during inflation?
A) Rising prices fail to signal desirable changes in the mix of output.
B) People buy different combinations of goods and services and own different combinations of wealth.
C) Relative prices remain unchanged.
D) All of the above are the case.
Answer: B Type: Basic Understanding Page: 131
23. Which of the following results from unexpected increases in the rate of inflation?
A) Decreased uncertainty.
B) Increased windfall profits to creditors who have lent large amounts of money.
C) Redistribution's of income and wealth between different groups.
D) All of the above.
Answer: C Type: Basic Understanding Page: 131
24. Inflation functions as a redistribution mechanism because people:
A) Buy different goods and services for which relative prices change during inflation.
B) Own different assets for which relative market values change with inflation.
C) Have incomes which respond differently to inflation.
D) All of the above are correct.
Answer: D Type: Basic Understanding Page: 131
25. Because some people's incomes rise faster than inflation while others people's incomes rise more slowly:
A) There are no adverse effects from inflation.
C) ARMs were created.
B) There are redistribution effects from inflation.
D) People shorten their time horizons.
Answer: B Type: Basic Understanding Page: 131
26. Inflation results in a redistribution of income and wealth because people:
A) Buy different goods and services for which relative prices change during inflation.
B) Own different kinds of assets whose relative market values change during inflation.
C) Receive incomes whose real purchasing power changes during inflation.
D) All of the above.
Answer: D Type: Analytical Page: 131
Page 5
Chapter 7: Inflation
27. Important microeconomic consequences of inflation include all of the following except:
A) Cyclical unemployment. B) Income effects. C) Wealth effects. D) Price effects.
Answer: A Type: Basic Understanding Page: 131
28. Which of the following is a microeconomic consequence of inflation?
A) A price effect. B) An income effect. C) A wealth effect. D) All of the above.
Answer: D Type: Basic Understanding Page: 131
29. A microeconomic consequence of inflation is:
A) Higher unemployment. B) The price effect.
C) A lower real GDP. D) All of the above.
Answer: B Type: Basic Understanding Page: 131
30. Your nominal income:
A) Is the amount of money you receive during a given time period.
B) Is measured in current dollars.
C) Does not measure purchasing power.
D) All of the above.
Answer: D Type: Definition Page: 133
31. The term "nominal income" refers to:
A) Money income adjusted for any change in the price level.
B) Real purchasing power.
C) Real purchasing power deflated for rising prices.
D) Money income measured in current dollars.
Answer: D Type: Definition Page: 133
32. Your real income is:
A) The amount of money you receive during a given time period.
B) Measured in current dollars.
C) The purchasing power of the money you receive.
D) All of the above.
Answer: C Type: Definition Page: 133
33. If the number of dollars you receive every year in income is the same, but prices are rising, then your nominal
income:
A) Rises and your real income rises.
C) Falls but your real income rises.
B) Rises but your real income falls.
D) Stays the same but your real income falls.
Answer: D Type: Complex Understanding Page: 133
Page 6
Chapter 7: Inflation
34. When the price of a product rises faster than the inflation rate:
A) The nominal incomes of the users of that product fall.
B) The users of that product have higher real incomes than people who do not use the product.
C) The nominal incomes of the users of that product rise.
D) The real incomes of the users of that product fall.
Answer: D Type: Basic Understanding Page: 133
35. If inflation is 13 percent per year and you receive no raise, then your:
A) Real income falls, but your nominal income remains unchanged.
B) Real and nominal income both fall.
C) Real income remains unchanged, but your nominal income rises.
D) Real income remains unchanged, but your nominal income falls.
Answer: A Type: Complex Understanding Page: 133
36. If inflation is 15 percent per year and you receive a 11 percent raise in income, then your:
A) Real and nominal income both fall.
C) Real income falls, but nominal income rises.
B) Real and nominal income both rise.
D) Real income rises, but nominal income falls.
Answer: C Type: Complex Understanding Page: 133
37. Which of the following groups is protected from a sudden increase in inflation?
A) Borrowers who have loans at fixed interest rates.
B) Fixed-income groups.
C) Workers who receive fixed wages under multiyear contracts.
D) People who rent their homes in comparison with those who own their homes.
Answer: A Type: Basic Understanding Page: 134
38. Which of the following is a microeconomic consequence of inflation?
A) Greater unemployment. B) Money illusion. C) The wealth effect.
D) All of the above.
Answer: C Type: Definition Page: 134
39. Generally speaking, which of the following groups would tend to gain real income from the wealth effects of
inflation?
A) People with fixed income.
B) People who have passbook savings accounts.
C) People who own assets that are appreciating faster than the inflation rate.
D) People who hold all of their assets in the form of cash.
Answer: C Type: Complex Understanding Page: 134
Page 7
Chapter 7: Inflation
40. During a period of unanticipated inflation:
A) Debtors are better off and creditors are worse off.
B) Debtors and creditors are both better off because of lower real interest rates.
C) Individuals on fixed incomes are better off.
D) All individuals are worse off because of the level of uncertainty.
Answer: A Type: Complex Understanding Page: 134
Use the following to answer questions 41-43:
INDEX OF NOMINAL WAGES AND PRICES
Figure 7.3
200
Prices
180
Wages
160
140
120
100
1970
1975
1980
1985
1990
1995
YEAR
41. According to Figure 7.3, an increase in average prices is accompanied by:
A) An increase in average wages so some people may not be worse off during inflation.
B) An increase in average wages so inflation does not cause a redistribution of income.
C) A slower increase in average wages because productivity has increased.
D) A slower increase in average wages and all individuals are adversely affected by inflation.
Answer: A Type: Complex Understanding Page: 132
42. During the time period represented in Figure 7.3, the purchasing power of the average worker:
A) Increased because nominal wages increased.
B) Decreased because real income decreased.
C) Stayed the same because COLAs probably kept purchasing power approximately constant.
D) Decreased because nominal income decreased.
Answer: B Type: Complex Understanding Page: 132
43. Which of the following definitely occurred in the economy depicted in Figure 7.3?
A) Recession. B) Stagflation. C) Economic growth. D) Inflation.
Answer: D Type: Complex Understanding Page: 130
Page 8
Chapter 7: Inflation
44. When people make their decisions on the basis of the face value of currency rather than the real value, their
decisions reflect:
A) The price effect of inflation.
C) The wealth effect of inflation.
B) The income effect of inflation.
D) Money illusion.
Answer: D Type: Complex Understanding Page: 136
45. Those who suffer from money illusion:
A) Recognize when their real income changes.
B) Are those who do not have a COLA clause in their employment contracts.
C) Confuse changes in nominal income with changes in real income.
D) Are those who work for less than the minimum wage.
Answer: C Type: Definition Page: 136
MACRO CONSEQUENCES
46. Which of the following is a macro consequence of sudden changes in the average level of prices?
A) People on fixed incomes suffer.
B) Uncertainty.
C) Nominal income falls by a smaller percentage than real income.
D) All of the above.
Answer: B Type: Basic Understanding Page: 136
47. The uncertainty that results from inflation changes:
A) Consumption, saving, and investment behavior.
B) Saving and investment behavior, but not consumption.
C) Consumption, but not saving and investment behavior.
D) Income, but not consumption.
Answer: A Type: Basic Understanding Page: 136
48. Which of the following is a macroeconomic effect of inflation?
A) The price effect. B) The wealth effect. C) Bracket creep.
D) All of the above.
Answer: C Type: Definition Page: 136
49. Which of the following might be a macroeconomic effect of inflation?
A) Redistribution of income.
C) A lower real GDP.
B) Redistribution of wealth.
D) All of the above.
Answer: C Type: Basic Understanding Page: 136
Page 9
Chapter 7: Inflation
50. Which of the following pushes a country inside its production-possibilities curve?
A) A sudden burst of inflation which has not been anticipated.
B) A sudden burst of deflation which has not been anticipated.
C) The withholding of resources from the production process because of speculation.
D) All of the above.
Answer: D Type: Complex Understanding Page: 136
51. Inflation affects production decisions because it:
A) Increases employment.
B) Reduces speculation.
C) Causes businesses to focus more on the future.
D) Causes businesses to be more cautious since the future is uncertain.
Answer: D Type: Complex Understanding Page: 137
52. Hyperinflation is:
A) An inflation rate in excess of 200 percent, lasting at least one year.
B) An inflation rate in excess of 200 percent, lasting at least one month.
C) A common problem in the United States.
D) All of the above.
Answer: A Type: Basic Understanding Page: 137
53. Speculation during periods of inflation can result in:
A) People buying resources for resale later rather than using the resources for current production.
B) A movement inside the institutional production-possibilities curve.
C) People buying gold, silver, jewelry, etc. instead of capital for production.
D) All of the above.
Answer: D Type: Basic Understanding Page: 137
54. Bracket creep refers to the:
A) Movement of taxpayers into higher tax brackets as nominal incomes grow.
B) Movement of taxpayers into higher tax brackets as real incomes grow.
C) Fact that governments lose tax revenue during periods of inflation.
D) Tendency for governments to lower tax rates during periods of inflation.
Answer: A Type: Definition Page: 137
MEASURING INFLATION
Page 10
Chapter 7: Inflation
55. The Consumer Price Index is a measure of the:
A) Index used to compute real GDP from nominal GDP.
B) Change in the average price of shipments of goods and services in the United States.
C) Average price of consumer goods and services in the current period relative to their price in some base
period.
D) Annual inflation rate in the producers' goods market.
Answer: C Type: Definition Page: 138
56. To construct the Consumer Price Index, the Bureau of Labor Statistics must:
A) Find out what people buy with their incomes and how the prices of what they buy change.
B) Find out why people buy what they do and how the prices of what they buy change.
C) Find out what is in the typical consumer market basket on the basis of what producers produce.
D) Conduct consumer expenditure surveys to determine how much prices rise.
Answer: A Type: Definition Page: 138
57. In order to compute the real income of a household, the index that should be used is the:
A) CPI. B) PPI. C) GDP deflator. D) COLA.
Answer: A Type: Basic Understanding Page: 138
58. Which of the following indexes gives the best indication of the inflation rate faced by consumers?
A) The GDP deflator. B) The industrial-production index. C) The PPI. D) The CPI.
Answer: D Type: Definition Page: 138
59. A sudden increase in inflation, ceteris paribus:
A) Raises the real income of lenders relative to borrowers.
B) Raises the CPI and reduces real income.
C) Reduces the nominal income of those who have constant real incomes.
D) Makes everyone worse off.
Answer: B Type: Basic Understanding Page: 138
60. Assume the CPI increases from 100 to 120 and a person's nominal income increases from $20,000 to $24,000
over the same period. This person's real income has:
A) Increased by 5 percent.
C) Increased by 20 percent.
B) Increased by 10 percent.
D) Remained the same.
Answer: D Type: Complex Understanding Page: 138
61. The base period used in computing a price index is:
A) The year in which prices were at their lowest level.
B) The year in which prices were at their average level.
C) A recent year from which meaningful comparisons can be made.
D) The earliest year for which data are available.
Answer: C Type: Definition Page: 138
Page 11
Chapter 7: Inflation
62. At the beginning of 1996 the CPI was 149.3. At the end of 1996 it was 153.7. What was the rate of inflation in
1996?
A) 4.4 percent. B) 4.0 percent. C) 2.9 percent. D) 1.03 percent.
Answer: C Type: Definition Page: 138
63. In 1991, the CPI was 131.1 and in 1997 the CPI was 158.2. What was the rate of inflation over this period of
time?
A) 20.7 percent. B) 31.1 percent. C) 27.1 percent. D) 17.1 percent.
Answer: A Type: Analytical Page: 138
64. If the Consumer Price Index rose from 167.4 in 1986 to 389.4 in 2011, what would the inflation rate be over
the period?
A) 222.0 percent. B) 14.8 percent. C) 43.0 percent. D) 133.0 percent.
Answer: D Type: Analytical Page: 138
65. If a price index rose from 16.2 in 1990 to 41.6 in 2011, what would the inflation rate be over the period?
A) 257 percent. B) 2.57 percent. C) 38.9 percent. D) 157 percent.
Answer: D Type: Analytical Page: 138
66. If the CPI increases from 200 to 240 for one year, the rate of inflation for that year is:
A) 10 percent. B) 12 percent. C) 20 percent. D) 5 percent.
Answer: C Type: Complex Understanding Page: 138
67. If the CPI increases from 100 to 130 for one year, the rate of inflation for that year is:
A) 30 percent. B) 13 percent. C) 10 percent. D) 5 percent.
Answer: A Type: Complex Understanding Page: 138
68. The PPI is the best index to measure average price changes faced by:
A) Consumers. B) Producers. C) Importers. D) Labor unions negotiating COLAs.
Answer: B Type: Basic Understanding Page: 140
69. If you were interested in charting prices charged by producers of energy which of the following would you
use?
A) The CPI. B) The PPI. C) The GDP deflator. D) The COLA.
Answer: B Type: Basic Understanding Page: 140
Page 12
Chapter 7: Inflation
70. Which of the following is often watched closely as a clue to potential changes in consumer prices in the
future?
A) The CPI. B) The PPI. C) The GDP deflator. D) The COLAs.
Answer: B Type: Basic Understanding Page: 140
71. Which of the following usually increases before the CPI increases?
A) GDP deflator. B) Consumer price index. C) Producer price index.
D) COLAs.
Answer: C Type: Basic Understanding Page: 140
72. At the beginning of 1985 the GDP deflator was 89.7. At the end of 2000 it was 163.7. The approximate rate of
inflation over the period is:
A) 74.0 percent. B) 82.5 percent. C) 54.8 percent. D) 180.0 percent.
Answer: B Type: Analytical Page: 140
73. The best price index to use in calculating real GDP is:
A) Any of the indexes since they all reflect price level changes.
B) The CPI.
C) The PPI.
D) The GDP deflator.
Answer: D Type: Basic Understanding Page: 140
74. Which of the following reflects changes in expenditure patterns as well as price changes?
A) The CPI. B) The PPI. C) The GDP deflator. D) The COLA.
Answer: C Type: Complex Understanding Page: 140
75. If nominal GDP is constant, then the GDP deflator varies inversely with:
A) The unemployment rate. B) Real GDP. C) COLAs. D) The CPI.
Answer: B Type: Complex Understanding Page: 140
76. If nominal GDP is $6,225.6 billion and the GDP deflator is 134.7, then real GDP is:
A) $4,621.8 billion. B) $46.2 billion. C) $6,360.3 billion. D) $6,090.9 billion.
Answer: A Type: Analytical Page: 140
77. If nominal GDP is $8,842.6 billion and the GDP deflator is 141.9, then real GDP is:
A) $8,984.5 billion. B) $62.3 billion. C) $6,231.6 billion. D) $8,700.7 billion.
Answer: C Type: Analytical Page: 140
Page 13
Chapter 7: Inflation
Use the following to answer questions 78-82:
Table 7.1
GDP
1998
1999
2000
Nominal GDP
(in billions of dollars)
$ 6,992.4
7,431.6
7,843.2
GDP deflator
106.2
109.1
112.3
CPI
151.6
153.8
157.8
78. Using the information in Table 7.1, the rate of inflation between 1998 and 1999 using the CPI is:
A) 1.5 percent. B) 2.2 percent. C) 6.2 percent. D) 4.1 percent.
Answer: A Type: Analytical Page: 138
79. Using the information in Table 7.1, the rate of inflation between 1999 and 2000 using the CPI is:
A) 6.2 percent. B) 4.1 percent. C) 1.0 percent. D) 2.6 percent.
Answer: D Type: Analytical Page: 138
80. Using the information in Table 7.1, the rate of inflation between 1998 and 2000 using the GDP deflator is:
A) 2.7 percent. B) 5.7 percent. C) 6.1 percent. D) 4.1 percent.
Answer: B Type: Analytical Page: 140
81. Using the information in Table 7.1, the real GDP for 1999 is:
A) $4,832.0 billion. B) $6,811.7 billion. C) $6,584.2 billion.
D) $6,984.1 billion.
Answer: B Type: Basic Understanding Page: 140
82. Using the information in Table 7.1, the real GDP for 2000 is:
A) $4,970.3 billion. B) $6,811.7 billion. C) $6,584.2 billion.
D) $6,984.1 billion.
Answer: D Type: Analytical Page: 140
THE GOAL: PRICE STABILITY
83. Price stability is defined as:
A) No change in relative prices.
B) The absence of significant changes in the average price level.
C) An inflation rate of zero.
D) Increases in prices equal to or less than the growth rate of the economy.
Answer: B Type: Basic Understanding Page: 140
Page 14
Chapter 7: Inflation
84. If some specific prices fall, some relative prices rise, and average prices remain unchanged, then there has
been a period of:
A) Stable prices. B) Inflation. C) Deflation. D) All of the above.
Answer: A Type: Definition Page: 140
85. In the Full Employment and Balanced Growth Act of 1978:
A) Congress set an inflation goal of 3 percent.
B) The President set an inflation goal of zero percent.
C) Alan Greenspan set an inflation goal of zero percent.
D) An unemployment goal of 4 percent was set, but no inflation goal could be set.
Answer: A Type: Basic Understanding Page: 140
86. Price stability:
A) Is defined as a zero percent rate of inflation in the Full Employment and Balanced Growth Act of 1978.
B) Is targeted at a 3 percent rate of inflation by Alan Greenspan, the head of the Federal Reserve.
C) Has been officially set by Congress at 3 percent.
D) Has been achieved consistently in the twentieth century in the United States.
Answer: C Type: Definition Page: 140
87. An inflation goal set at a low rate but greater than zero:
A) Increases the level of unemployment.
B) Limits GDP growth.
C) Allows for price increases caused by quality improvements.
D) Causes real GDP to decrease.
Answer: C Type: Complex Understanding Page: 141
88. An inflation goal set at a low rate but greater than zero allows:
A) The economy to achieve both full employment and price stability at the same time.
B) For errors because of new products.
C) For price increases caused by quality improvements.
D) All of the above.
Answer: D Type: Complex Understanding Page: 141
89. If the CPI doesn't measure product quality improvements, then the CPI tends to:
A) Understate the inflation rate.
C) Understate economic growth.
B) Overstate the inflation rate.
D) Be artificially low.
Answer: B Type: Definition Page: 141
Page 15
Chapter 7: Inflation
THE HISTORICAL RECORD
90. Which one of the following statements about inflation in the U.S. is correct?
A) Prior to World War II, the U.S. experienced periods of both deflation and inflation.
B) The U.S. has experienced inflation virtually every year since 1800.
C) Since World War II, the U.S. experienced deflation.
D) Prior to World War II, the U.S. experienced deflation virtually every year; since World War II, the U.S.
has consistently experienced inflation.
Answer: A Type: Basic Understanding Page: 142
91. Which one of the following statements about inflation in the U.S. is correct?
A) Since the Great Depression, average prices have risen almost every year.
B) The inflation rate was 13.5 percent in 1980.
C) Prior to World War II, the U.S. experienced periods of both deflation and inflation.
D) All of the above.
Answer: D Type: Basic Understanding Page: 142
CAUSES OF INFLATION
92. If consumers attempt to buy more goods than the economy can produce, the result is:
A) Unemployment. B) Demand-pull inflation. C) Cost-push inflation. D) The wealth effect.
Answer: B Type: Basic Understanding Page: 144
93. When production costs increase and producers raise output prices, the result is:
A) The price effect. B) Unemployment. C) Cost-push inflation. D) Demand-pull inflation.
Answer: C Type: Basic Understanding Page: 144
PROTECTIVE MECHANISMS
94. Which of the following automatically adjusts some nominal wages to changing price indexes?
A) The CPI. B) The PPI. C) The GDP deflator. D) The COLA.
Answer: D Type: Definition Page: 144
95. Which of the following is not an index of weighted average prices?
A) COLA. B) CPI. C) GDP deflator. D) PPI.
Answer: A Type: Basic Understanding Page: 144
Page 16
Chapter 7: Inflation
96. Cost-of-living adjustments:
A) Reduce the price effect of inflation.
B) Allow individuals to maintain their purchasing power during inflation.
C) Cause individuals to shorten their time horizons.
D) Maintain constant real interest rates.
Answer: B Type: Complex Understanding Page: 144
97. When inflation suddenly increases, ARMs:
A) Protect against rising real interest rates.
B) Protect the purchasing power of workers' wages.
C) Protect borrowers against the effects of inflation.
D) Maintain a stable rate of real interest.
Answer: D Type: Definition Page: 144
98. The objective of adjustable-rate mortgages is to:
A) Maintain a stable rate of real interest.
B) Protect debtors from an unanticipated loss of real wealth.
C) Increase the gap between nominal and real incomes.
D) Reduce transfer payments.
Answer: A Type: Complex Understanding Page: 144
99. The real interest rate is:
A) The difference between the prime rate and the rate charged by the government (Federal Reserve) on
loans.
B) The nominal interest rates minus the anticipated rate of inflation.
C) The inflation rate minus the percentage increase in average wages.
D) The sum of inflation rates and unemployment rates.
Answer: B Type: Definition Page: 144
100. The real interest rate:
A) Is stabilized by ARMs.
B) Is protected by COLAs.
C) Becomes larger with sudden changes in anticipated inflation rates.
D) All of the above.
Answer: A Type: Definition Page: 144
101. The real interest rate is:
A) The nominal interest rate minus the anticipated rate of inflation.
B) Stabilized by ARMs.
C) The inflation-adjusted rate of interest.
D) All of the above.
Answer: D Type: Definition Page: 144
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Chapter 7: Inflation
102. If the nominal interest rate is 12 percent and the inflation rate is 9 percent, the real interest rate is:
A) 12 percent. B) 21 percent. C) 3 percent. D) -3 percent.
Answer: C Type: Analytical Page: 144
103. If the nominal interest rate is 9 percent and the inflation rate is 13 percent, the real interest rate is:
A) -4 percent. B) 4 percent. C) 22 percent. D) 9 percent.
Answer: A Type: Analytical Page: 144
104. If the nominal interest rate is 5 percent and the inflation rate is 5 percent, the real interest rate is:
A) 5 percent. B) 10 percent. C) -5 percent. D) 0 percent.
Answer: D Type: Analytical Page: 144
105. If the nominal interest rate is 11 percent and the real interest rate is 11 percent then:
A) The expected rate of inflation is 22 percent.
C) Real GDP must exceed nominal GDP
B) The expected rate of inflation is 0 percent.
D) Nominal GDP must exceed real GDP.
Answer: B Type: Complex Understanding Page: 144
Use the following to answer questions 106-108:
Figure 7.4
7
INTEREST RATE
(percent per year)
6
Nominal
interest
rate
5
4
Real
interest
rate
3
2
1
1970
1975
1980
1985
1990
1995
YEAR
106. Using Figure 7.4, expected inflation was:
A) Greater during the period from 1970 to 1975 than it was during the period from 1980 to 1985.
B) The same in 1970 and 1995.
C) Greater in 1970 than in 1995.
D) Greater during the period from 1980 to 1985 than it was during the period from 1970 to 1975.
Answer: D Type: Complex Understanding Page: 144
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Chapter 7: Inflation
107. For the economy represented in Figure 7.4, which of the following statements is definitely true?
A) Anticipated inflation was greater than actual inflation.
B) Actual inflation was greater than anticipated inflation.
C) Inflation was anticipated.
D) Inflation occurred.
Answer: D Type: Complex Understanding Page: 144
108. For the economy represented in Figure 7.4, if actual inflation was greater than anticipated inflation:
A) Borrowers would experience an increase in real income.
B) Lenders would experience an increase in real income.
C) All workers would experience a decrease in real income.
D) The wealth effect would redistribute purchasing power to people on fixed incomes.
Answer: A Type: Complex Understanding Page: 144
THE ECONOMY TOMORROW
109. The most fundamental function of prices in a market economy is to provide:
A) The data necessary to calculate rates of inflation.
B) The basis for the calculation of sales tax.
C) Information about the relative scarcities of resources and goods and services.
D) Maximum profits to producers.
Answer: C Type: Basic Understanding Page: 146
110. The most desirable inflation rate is the rate that:
A) Equals the official goal of 3 percent.
B) Least effects the behavior of companies, investors, consumers and workers.
C) Maximizes the "wealth effect" of inflation
D) Coincides with an unemployment rate of zero percent.
Answer: B Type: Basic Understanding Page: 146
The following multiple-choice questions require critical thinking about In the News and World View articles that
appeared in the text.
111. According to an In the News article titled "Public Colleges' Tuition Rises 7.7% this Fall," relative to other
households, parents sending students to college are most likely to experience a relative:
A) Decline in real income.
C) Decline in nominal income.
B) Rise in real income.
D) Rise in nominal income.
Answer: A Type: Complex Understanding Page: 131
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Chapter 7: Inflation
112. According to an In the News article titled "Public Colleges' Tuition Rises 7.7% this Fall," relative to other
parents, parents of college-bound students experience:
A) Both a higher relative price of tuition's and fees and a higher inflation rate.
B) A lower relative price of tuition's and fees and a higher inflation rate.
C) A higher relative price of tuition's and fees and a lower inflation rate.
D) Both a lower relative price of tuition's and fees and a lower inflation rate.
Answer: A Type: Complex Understanding Page: 131
113. According to an In the News article titled "Public Colleges' Tuition Rises 7.7% this Fall," if university
enrollments do not fall, then universities should experience:
A) Both higher nominal and real income.
C) Lower nominal income but higher real income.
B) Higher nominal but lower real income.
D) Both lower real and nominal income.
Answer: A Type: Complex Understanding Page: 131
114. The World View article "Worldwide Inflation" gives the inflation rates of various countries. Money held in a
savings account in countries with high inflation tends to lose value. This is an example of the:
A) Price effect of inflation.
C) Wealth effect of inflation.
B) Income effect of inflation.
D) Money illusion.
Answer: C Type: Complex Understanding Page: 134
115. The World View article "Worldwide Inflation" gives the inflation rates of various countries. Which of the
following is a macro consequence of inflation?
A) Bracket creep. B) Uncertainty. C) Shortened time horizons. D) All of the above.
Answer: D Type: Complex Understanding Page: 136
116. A World View article "Worldwide Inflation" gives the inflation rates of various countries. If nominal incomes
do not keep pace with inflation, the result is referred to as the:
A) Price effect of inflation.
C) Wealth effect of inflation.
B) Income effect of inflation.
D) Bracket creep.
Answer: B Type: Definition Page: 133
117. The World View article "Tortilla Price Hike Hits Mexico's Poorest" describes one effect of Mexico's inflation.
People who rely on tortillas “… for half their daily diet” are likely to experience the:
A) Price effect of inflation.
C) Wealth effect of inflation.
B) Income effect of inflation.
D) Money illusion.
Answer: A Type: Complex Understanding Page: 131
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Chapter 7: Inflation
True/False Questions
WHAT IS INFLATION?
T
F 118. Inflation always occurs when an index of weighted average prices rises.
Answer: True Type: Definition Page: 130
T
F 119. Inflation involves increases in specific prices, not relative prices or average prices.
Answer: False Type: Definition Page: 130
T
F 120. Deflation is a decrease in the average level of prices, not a decrease in any specific price.
Answer: True Type: Definition Page: 130
T
F 121. Relative price changes are a desirable and essential ingredient of the market mechanism.
Answer: True Type: Basic Understanding Page: 130
T
F 122. When there is no deflation and no inflation, there can still be changes in relative prices.
Answer: True Type: Basic Understanding Page: 130
RESTRIBUTIVE EFFECTS
T
F 123. The redistribution of income is a microeconomic effect of inflation.
Answer: True Type: Basic Understanding Page: 131
T
F 124. Everyone is made worse off by inflation.
Answer: False Type: Basic Understanding Page: 131
T
F 125. Some buyers respond to inflation by cutting back on purchases of goods and services, whereas
others respond by making greater purchases of goods and services.
Answer: True Type: Basic Understanding Page: 131
T
F 126. When restaurant prices rise faster than prices of food at grocery stores, real income falls for people
who visit restaurants relative to those who cook for themselves.
Answer: True Type: Complex Understanding Page: 131
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Chapter 7: Inflation
T
F 127. When prices of movie tickets rise faster than prices of concert tickets, real income rises for people
who go to movies relative to those who go to concerts.
Answer: False Type: Complex Understanding Page: 131
T
F 128. If your real income rises but your nominal income falls, then you benefit from deflation.
Answer: True Type: Basic Understanding Page: 131
T
F 129. Real income is the amount of money income received in a given time period, measured in current
dollars.
Answer: False Type: Definition Page: 131
T
F 130. When a person's real income falls in a period of inflation, then the person's nominal income must
fall.
Answer: False Type: Basic Understanding Page: 131
T
F 131. When a person's nominal income rises but his or her real income falls, then average prices have
risen.
Answer: True Type: Basic Understanding Page: 131
T
F 132. Redistribution of wealth is a microeconomic effect of inflation.
Answer: True Type: Basic Understanding Page: 131
T
F 133. Money illusion results from expectations based on current nominal income rather than real
purchasing power.
Answer: True Type: Basic Understanding Page: 136
MACRO CONSEQUENCES
T
F 134. Uncertainty and speculation are microeconomic effects of inflation.
Answer: False Type: Basic Understanding Page: 136
T
F 135. Production replaces speculation during a period of hyperinflation.
Answer: False Type: Basic Understanding Page: 137
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Chapter 7: Inflation
T
F 136. The undesirable effects of bracket creep can be eliminated by indexing marginal tax rates.
Answer: True Type: Basic Understanding Page: 137
MEASURING INFLATION
T
F 137. The CPI, in the long run, usually indicates a higher inflation rate than the PPI.
Answer: False Type: Basic Understanding Page: 138
T
F 138. The GDP deflator is the only output index based on a fixed market basket through time.
Answer: False Type: Basic Understanding Page: 140
THE GOAL: PRICE STABILITY
T
F 139. Price stability is a major goal of economic policy.
Answer: True Type: Basic Understanding Page: 140
T
F 140. In order to achieve price stability, inflation must be zero.
Answer: False Type: Basic Understanding Page: 140
T
F 141. The goal of price stability was first established as public policy in the Full Employment and
Balanced Growth Act of 1978.
Answer: True Type: Basic Understanding Page: 140
T
F 142. A goal of 3 percent inflation allows for quality improvements.
Answer: True Type: Basic Understanding Page: 141
THE HISTORICAL RECORD
T
F 143. On average, U.S. inflation rates have been lower than the rates in most other countries.
Answer: True Type: Basic Understanding Page: 142
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Chapter 7: Inflation
T
F 144. The United States has experienced periods of inflation, but it has never experienced periods of
deflation.
Answer: False Type: Basic Understanding Page: 142
CAUSES OF INFLATION
T
F 145. Demand-pull inflation is the result of excessive pressure on the demand side of the economy.
Answer: True Type: Basic Understanding Page: 144
T
F 146. Cost-push inflation is the result of consumers trying to acquire more goods.
Answer: False Type: Basic Understanding Page: 144
PROTECTIVE MECHANISMS
T
F 147. The real interest rate is stabilized by ARMs.
Answer: True Type: Basic Understanding Page: 144
T
F 148. The real interest rate is the rate of inflation minus the nominal interest rate.
Answer: False Type: Basic Understanding Page: 144
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