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35 Cards in this Set

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The increase in the overall level of prices is called...
Inflation
How do economists measure inflation rate?
As the percentage change in the consumer price index (CPI), the GDP deflator, or some other index of the overall price level.
Over the past 70 years, how much has the price levels risen?
On average of about 4 percent per year.
What is deflation?
A phenomenon when prices levels actually decrease.
What is hyperinflation?
Extreme rate of inflation.
Inflation is more about the value of money than...
...about the value of goods.
Inflation is an economy-wide phenomenon that concerns, first and foremost, the value of...
...the economy's medium of exchange.
What is the quantity of goods and services that can be bought with $1?
1/P

(In other words, if P is the price of goods and services measured in terms of money, 1/P is the value of money measured in terms of goods and services.)
What determines the value of money?
Supply and demand.
The demand for money reflects how much wealth people want to hold in what kind of form?
Liquid form
The theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate is called what?
The quantity theory of money.
What is the immediate effect of a monetary injection?
To create an excess supply of money. Inject of money also increases the demand for goods and services because people have more money.
What is not altered by the injection of money?
The economy's output of goods and services is determined by the available labor, physical capital, human capital, natural resources, and technological knowledge. None of these is altered by the injection of money.
What are nominal variables?
Variables measured in monetary units. For example, income of corn farmers is a nominal variable because it is measured in dollars.
What are real variables?
Variables measured in physical units. For example, the quantity of corn farmers produce is a real variable because it is measured in bushels.
What is the theoretical separation of nominal and real variables called?
Classical dichotomy.
Are relative prices nominal or real variables?
Real variables.
What is monetary neutrality?
The proposition that changes in the money supply do not affect real variables.
What is the velocity of money?
The rate at which money changes hands.
How do you calculate the velocity of money?
We divide the nominal value of output (nominal GDP) by the quantity of money. If P is the price level (the GDP deflator), Y the quantity of outputs (real GDP), and M the quantity of money, then velocity is V=(PxY)/M
What is the quantity equation?
M x V = P x Y

Relates the quantity of money, the velocity of money, and the dollar value of the economy's output of goods and services.
The quantity equation shows that an increase in the quantity of money in an economy must be reflected in what three variables?
The price level must rise, the quantity of output must rise, or the velocity of money must fall.
True or False. The velocity of money is relatively stable.
True
Why do the central banks of countries experiencing hyperinflation choose to print so much money that its value is certain to fall rapidly over time?
The government of these countries are using money creation as a way to pay for their spending.
What is inflation tax?
The revenue the government raises by creating money. The inflation tax is different from other taxes because no one receives a bill from the government for this tax. When the government prints money, the price level rises, and the dollars in your wallet are less valuable. The inflation tax is like a tax on everyone who holds money.
Nominal interest rate
Interest rate you hear about at your bank. If you have a savings account, for instance, the nominal interest rate tells you how fast the number of dollars in your account will rise over time.
Real interest rate
Corrects the nominal interest rate for the effect of inflation to tell you how fast the purchasing power of your savings account will rise over time.
What is the equation for the real interest rate?
Real interest rate = Nominal interest rate - Inflation rate
What is the equation for the nominal interest rate?
Nominal interest rate = Real interest rate + Inflation rate
If in the long run money is neutral, does a change in money growth affect the real interest rate?
No.

See Fisher effect.
What is the Fisher effect?
The one-to-one adjustment of the nominal interest rate to the inflation rate. This adjustment is needed in order for the real interest rate not to be affected by change in money growth. Thus, when the Fed increases the rate of money growth, the long-run results is both a higher inflation rate and a higher nominal interest rate.
Does inflation reduce people's real purchasing power?
No. When prices rise, buyers of goods and services pay more for what they buy. At the same time, however, sellers of goods and services get more for what they sell. Because most people earn their incomes by selling their services, such as their labor, inflation in incomes goes hand in hand with inflation in prices.
What are shoeleather costs?
The resources wasted when inflation encourages people to reduce their money holdings.
What are menu costs?
The costs of changing prices. Includes cost of deciding on new prices, the cost of printing new price lists and catalogs, the cost of sending these new prices and catalogs to dealers and customers, the cost of advertising the new prices, and even the cost of dealing with customer annoyance over price changes.
Annual price adjustment are practical during times of low inflation or high inflation?
Low inflation