Macro Tut 6: The Money Growth & Inflation

Multiple Choice: Identify the choice that best completes the statement or answers the question.

1. The price level rises if either

a. money demand shifts rightward or money supply shifts leftward; this rise in the price level is associated
with a rise in the value of money.
b. money demand shifts rightward or money supply shifts leftward; this rise in the price level is associated
with a fall in the value of money.
c. money demand shifts leftward or money supply shifts rightward; this rise in the price level is associated
with a rise in the value of money.
d. money demand shifts leftward or money supply shifts rightward; this rise in the price level is associated
with a fall in the value of money.

2. If velocity = 5, the price level = 1.5, and the real value of output is 2,500, then the quantity of
money is
a. 333.33.
b. 750.00.
c. 1,050.00.
d. 8,333.33.

3. When the money market is drawn with the value of money on the vertical axis, an increase in the
money supply causes the equilibrium value of money
a. and equilibrium quantity of money to increase.
b. and equilibrium quantity of money to decrease.
c. to increase, while the equilibrium quantity of money decreases.
d. to decrease, while the equilibrium quantity of money increases.
4. When the money market is drawn with the value of money on the vertical axis, an increase in the
money supply creates an excess
a. supply of money, causing people to spend more.
b. supply of money, causing people to spend less.
c. demand for money, causing people to spend more.
d. demand for money, causing people to spend less.

Figure 30-2. On the graph, MS represents the money supply and MD represents money demand. The
usual quantities are measured along the axes.

MS
1.125

0.875

0.75

0.625

0.5
MD
0.375 2
0.25 MD1
0.125

5,000

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5. Refer to Figure 30-2. If the relevant money-demand curve is the one labeled MD1, then the
equilibrium value of money is
a. 0.5 and the equilibrium price level is 2.
b. 2 and the equilibrium price level is 0.5.
c. 0.5 and the equilibrium price level cannot be determined from the graph.
d. 2 and the equilibrium price level cannot be determined from the graph.

Figure 30-3. On the graph, MS represents the money supply and MD represents money demand. The
usual quantities are measured along the axes.

MS MS
1 2

0.5

0.33
MD

10,000 15,000

6. Refer to Figure 30-3. What quantity is measured along the vertical axis?
a. the price level
b. the velocity of money
c. the value of money
d. the quantity of money
7. According to the classical dichotomy, which of the following is influenced by monetary factors?
a. real GDP
b. unemployment
c. nominal interest rates
d. All of the above are correct.

8. According to the classical dichotomy, which of the following is not influenced by monetary
factors?
a. nominal GDP and nominal interest rates
b. real wages and real GDP
c. the price level and nominal GDP
d. None of the above is correct.

9. Velocity is computed as
a. (P Y)/M.
b. (P M)/Y.
c. (Y M)/P.
d. (Y M)/V.

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10. If Y and M are constant, and V doubles, the quantity equation implies that the price level
a. falls to half it’s original level.
b. doubles.
c. more than doubles.
d. does not change.

11. Suppose over some period of time the money supply tripled, velocity fell by half, and real GDP
doubled. According to the quantity equation the price level is now
a. 6 times its old value.
b. 3 times its old value.
c. 1.5 times its old value.
d. 0.75 times its old value.
12. Suppose that when the money supply changes, real output and velocity do not change. Then a 2
percent increase in the money supply
a. decreases the price level by 2 percent.
b. decreases the price level by less than 2 percent.
c. increases the price level by less than 2 percent.
d. increases the price level by 2 percent.

13. If money is neutral and velocity is stable, an increase in the money supply creates a
proportional increase in
a. real output only.
b. nominal output only.
c. the price level only.
d. both the price level and nominal output.

14. The inflation tax

a. transfers wealth from the government to households.
b. is the increase in income taxes due to lack of indexation.
c. is a tax on everyone who holds money.
d. All of the above are correct.
15. Higher inflation makes relative prices
a. more variable, making it more likely that resources will be allocated to their best use.
b. more variable, making it less likely that resources will be allocated to their best use.
c. less variable, making it more likely that resources will be allocated to their best use.
d. less variable, making it less likely that resources will be allocated to their best use.

16. In the U.S., people are required to pay taxes on

a. nominal interest earnings, irrespective of their real interest earnings.
b. real interest earnings, irrespective of their nominal interest earnings.
c. real capital gains, irrespective of their nominal capital gains.
d. All of the above are correct.
17. You bought some shares of stock and, over the next year, the price per share increased by 5
percent, as did the price level. Before taxes, you experienced
a. both a nominal gain and a real gain, and you paid taxes on the nominal gain.
b. both a nominal gain and a real gain, and you paid taxes only on the real gain.
c. a nominal gain, but no real gain, and you paid taxes on the nominal gain.
d. a nominal gain, but no real gain, and you paid no taxes on the transaction.

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18. You put money into an account and earn an after-tax real interest rate of 2.5 percent. If the
nominal interest rate on the account is 8 percent and the inflation rate is 2 percent, then what is the
tax rate?
a. 28.00 percent
b. 36.25 percent
c. 43.75 percent
d. 67.50 percent

19. For a given real interest rate, a decrease in the inflation rate would
a. decrease the after-tax real interest rate and so decrease saving.
b. decrease the after-tax real interest rate and so increase saving.
c. increase the after-tax real interest rate and so decrease saving.
d. increase the after-tax real interest rate and so increase saving.

20. If the economy unexpectedly went from inflation to deflation,

a. both debtors and creditors would have reduced real wealth.
b. both debtors and creditors would have increased real wealth.
c. debtors would gain at the expense of creditors.
d. creditors would gain at the expense of debtors.

PROBLEM
Problem 1:
Suppose that this year’s money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5
trillion.
a. What is the price level? What is the velocity of money?
b. Suppose that velocity is constant and the economy’s output of goods and services rises by 5 percent
each year. What will happen to nominal GDP and the price level next year if the Fed keeps the money
supply constant?
c. What money supply should the Fed set next year if it wants to keep the price level stable?
d. What money supply should the Fed set next year if it wants inflation of 10 percent?
Problem 2:
If the tax rate is 40 percent, compute the before tax real interest rate and the after-tax real interest rate in
each of the following cases.
a. The nominal interest rate is 10 percent, and the inflation rate is 5 percent.
b. The nominal interest rate is 6 percent, and the inflation rate is 2 percent.
c. The nominal interest rate is 4 percent, and the inflation is 1 percent.
Problem 3:
Assume that the quantity theory of money holds and that velocity is constant at 5. Output is fixed at its
full-employment value of 10,000, and the price level is 2.
a- Determine the real demand for money and the nominal demand for money.
b- In this same economy the government fixes the nominal money supply at 5000. With output fixed at
its full-employment level and with the assumption that prices are flexible, what will be the new price
level? What happens to the price level if the nominal money supply rises to 6000?

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