NAME ___________________________________

CHAPTER 8: INFLATION

DEFINITIONS

1. Inflation

2. Inflation rate

3. Deflation

4. Income effect

5. Wealth effect

6. Demand-pull inflation

7. Income approach

8. Cost-push inflation

9. Hyperinflation

10. Stagflation
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MULTIPLE CHOICE

1. Inflation is defined as
a. any increase in the general price level.
b. a sustained increase in the weighted average of all prices.
c. a sustained increase in relative prices.
d. an increase in the prices of specific products.
e. a sudden increase in the weighted average of all prices.

2. The purchasing power of money

a. increases as the level of relative prices decreases.
b. has been rising in the United States since de 1940’s.
c. is the nominal value of money.
d. is the nominal value of income.
e. is the value of goods and services that can be bought with a dollar.

3. During periods of inflation,

a. everyone’s real income falls.
b. those people benefit who have fixed incomes.
c. those people benefit whose real income rises faster than the general price
level.
d. those people benefit who enter long term wage agreements.
e. those people benefit who hold a lot of cash.

4. If increases in total spending are not offset by increases in the supply of goods and
services, the average level of prices will rise. Which of the following is responsible?
a. cost-push inflation
b. profit-push inflation
c. demand-pull inflation
d. wage-push pressures
e. unemployment
5. When the economy is operating at full capacity, we might expect.
a. cost-push inflation.
b. demand-pull inflation
c. profit-push inflation.
d. wage-push inflation
e. no inflation at all.

6. Cost-push inflation is caused by

a. full employment of resources in the economy.
b. excessive government spending.
c. Excess raw materials.
d. the demand side of the market.
e. the supply side of the market.
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7. Annual inflation rates

a. are about the same across countries.
b. are higher in developing countries than in industrial countries.
c. are higher in industrial countries than in developing countries.
d. are not linked to the monetary policy of a country
e. remain relatively stable over time.

8. Hyperinflation
a. causes the value of a currency to deteriorate so quickly that people become
reluctant to hold that currency.
b. is a situation where people hoard currency.
c. is a simultaneous increase in the inflation and a decrease in the quality of
products.
d. occurred in the States in the 1970’s
e. is a synonym for cost-push inflation.

9. The introduction of a new currency in developing countries is generally a sign of

a. an economic depression.
b. a misguided political situation.
c. social instability.
d. hyperinflation.
e. deflation.

10. If a college professor’s income has increased by 3 percent at the same time that prces
have risen by 5 percent, the professor’s real income has
a. decreased by 2 percent
b. increased by 2 percent.
c. increased by 7 percent.
d. decreased by 7 percent.
e. not changed.

RESOURCES
ECONOMICS BOYES/MELVIN
NAME ___________________________________

TRUE/FALSE
Directions: For the following statements, indicate whether the statement is true or false. If the
statement is false, make the necessary change(s) in order for it to be a true statement.

1. Because inflation and deflation are measured in terms of relative price levels, it is possible for
average prices to rise or fall continuously without changing the individual price level.
False; because inflation and deflation are measured in terms of average price levels, it’s
possible for individual prices to rise or fall continuously without changing the average price
level.

2. One reason that economists are concerned about the inflation rate is because it affects the cost
of living and the cost of inputs.
True

3. The income and substitution effects are some of the microeconomic effects of inflation
mentioned in the chapter.
False; the income and wealth effects are some of the microeconomic effects of inflation.

4. Some of the macroeconomic effects mentioned in the chapter include the wealth effect,
uncertainty, price effect, and tax effects.
False; some of the macroeconomic effects include uncertainty, tax effects, and speculation.

5. An example of cost-push inflation is when the Federal Reserve decides to increase the money
supply in the economy.
False; this is an example of demand-pull inflation

6. Cost-push inflation is not as much of a concern to an economy as demand-pull inflation.

False; demand-pull inflation is much more tolerable to the economy than cost-push
inflation.

7. Stagflation occurs when inflation is increasing and the economy is experiencing negative
growth (or recession).
True

8. Some ways to measure the price level include the Consumer Price Index, the Producer Price
Index, and the GDP inflator.
False; price levels can be measured by the CPI, PPI, and GDP deflator.
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9. The GDP deflator is the most important and most commonly used index when computing the
price level.
False; the CPI is the most commonly used and most important index used in calculating the
price level.

10. The difference between real and nominal GDP is that nominal GDP factors in the effects of
inflation.
False; real GDP factors in the effects of inflation.

11. When calculating the price level, the base year is always defined as the year with the highest
price index.
False; the base year is always identified by a price index of 1 or 100.
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ESSAY QUESTIONS

Questions:

The table below shows a) the actual average nominal income per hour in Country X; b) CPI for
each year with base period = 1982.

i. Calculate the real income and fill in the cells below:

Year Nominal Income CPI Real Income

($ per hour)

1960 2.43 29.6 8.20

1970 4.25 38.8 10.95

1980 9.70 82.4 11.77

1990 16.30 130.7 12.47

ii. Complete the table below

Percentage change in Percentage change in real

Years Nominal income income

1960-1970 74.9% 33%

1970-1980 128% 7.4%

1980-1990 68% 5.9%

iii. You worked for Wal-mart from 1980-1990. From 1980 to 1989 you earned the same
wage of $9.00 an hour. In 1990 you got a 40% raise in your hourly wage. Is you real wage in
1990 higher than your real wage in 1980? Show all your work (Use CPI information from the
table).

Nominal CPI Real

1980 $9 82.4 $10.9
1990 $12.6 130.7 $9.64
NAME ___________________________________

Therefore, 1990s real wage is lower than 1980s