THE UNIVERSITY OF THE WEST INDIES

FIVE ISLANDS CAMPUS, ANTIGUA AND BARBUDA

SCHOOL OF MANAGEMENT, SCIENCE AND TECHNOLOGY

ECON2003: INTERMEDIATE MACROECONOMICS II – SEMESTER II

TUTORIAL SHEET 5

1. During World War II, both Germany and England had plans for a paper weapon: they
each printed the other’s currency, with the intention of dropping large quantities by
airplane. Why might this have been an effective weapon?
A paper weapon could not be efficient because it could lead to the hyperinflation. It
would increase menu costs for example. In addition it would also change tax
liabilities, prices would change more often, etc. Overall its effect could lead to people
losing confidence in economic policy of the country.

2. Currently, many banks offer online services that save customers a trip to the bank. In
addition, ATMs and debit cards allow depositors twenty-four-hour access to their
balances. Comment on the effects of online banking and ATMs on shoe-leather costs.
Online banking and ATMs have decreased shoe-leather costs.

3. Explain the roles of monetary and fiscal policy in causing and ending hyperinflations.
In regards to the monetary policy and its role in hyperinflation, most common answer is
that hyperinflation is a result of growth in money supply. Price levels will grow as long as
supply of money grows. In order to stop hyperinflation, first step would be that the
central bank stops printing money. In addition to this, government could try and to
finance its deficit through bonds, but if there is no one to buy them then it must find
another way. In this case, government turns to the simplest solution, printing money. In
order to stop inflation, government must increase taxes and focus on government
spending.

4. In each of the following scenarios, explain and categorize the cost of inflation:

a. Because inflation has risen, the L.L. Bean Company decides to issue a new
catalog quarterly rather than annually.
Menu cost - the company would need to adjust its prices in catalogue
more often so that the prices will keep up with the costs
b. Grandma buys an annuity for $100,000 from an insurance company, which
promises to pay her $10,000 a year for the rest of her life. After buying it, she is
surprised that high inflation triples the price level over the next few years.
Unexpected inflation will reduce the value of the annuity, which is more
beneficiary to the debtors and not to the creditors. Insurance company, in this
case, will pay grandpa dollars that are less valuable then they were before
 c. Maria lives in an economy with hyperinflation. Each day after being paid, she
runs to the store as quickly as possible so she can spend her money before it
loses value.
This is the example of shoeleather cost, since Maria must hurry in order to
exchange her money for goods and service thus losing energy and time
d. Warren lives in an economy with an inflation rate of 10 percent. Over the
past year, he earned a return of $50,000 on his million-dollar portfolio of
stocks and bonds. Because his tax rate is 20 percent, he paid $10,000 to
the government.
Here we have problems with tax laws that they do not take into account
changes in inflation. Gil, in this case, is being taxed on her nominal gain not
her real gain
e. Your father tells you that when he was your age, he worked for only $3 an
hour. He suggests that you are lucky to have a job that pays $7 an hour.
If inflation rate does not exceeds 125% for time period between when my
father worked and time that I have worked I think that I am luckier. On
the other hand, to really see who is better off we need to compare
purchasing power of the money in two periods.

5. If the price level was already doubling every month and inflation accelerating, what
would you expect to happen to the velocity of circulation and why? How close would
you expect the relation between the quantity of money and the price level to be?

March 1, 2021