PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

CHAPTER 7: INFLATION AND PHILLIPS CURVE

PART 1: MULTIPLE CHOICE QUESTIONS
1. Inflation can be measured by the
A. change in the consumer price index.
B. percentage change in the consumer price index.
C. percentage change in the price of a specific commodity.
D. change in the price of a specific commodity.
2. When the price level falls, the number of dollars needed to buy a representative basket
of goods
A. increases, so the value of money rises.
B. increases, so the value of money falls.
C. decreases, so the value of money rises.
D. decreases, so the value of money falls.
3. The supply curve of money is vertical because the quantity of money supplied increases
A. when the value of money increases.
B. when the value of money decreases.
C. only if people desire to hold more money.
D. only if the central bank increases the money supply.
4. The supply of money is determined by
A. the price level.
B. the Treasury and Congressional Budget Office.
C. the Federal Reserve System.
D. the demand for money.
5. The supply of money increases when
A. the value of money increases.
B. the interest rate increases.
C. the Fed makes open-market purchases.
D. None of the above is correct.
6. As the price level increases, the value of money
A. increases, so the quantity of money demanded increases.
B. increases, so the quantity of money demanded decreases.
C. decreases, so the quantity of money demanded decreases.
D. decreases, so the quantity of money demanded increases.
7. As the price level decreases, the value of money
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

A. increases, so people want to hold more of it.

B. increases, so people want to hold less of it.
C. decreases, so people want to hold more of it.
D. decreases, so people want to hold less of it.
8. Which of the following is correct?
A. If the Fed purchases bonds in the open market, then the money supply shifts right. A
change in the price level does not shift money supply.
B. If the Fed sells bonds in the open market, then money supply shifts right. A change in
the price level does not shift money supply.
C. If the Fed purchases bonds, then the money supply shifts right. An increase in the price
level shifts money supply right.
D. If the Fed purchases bonds, then the money supply shifts right. A decrease in the price
level shifts money supply right.
9. The velocity of money is
A. the rate at which the Fed puts money into the economy.
B. the same thing as the long-term growth rate of the money supply.
C. the money supply divided by nominal GDP.
D. the average number of times per year a dollar is spent.
10. Velocity is computed as
A. (P x Y)/M.
B. (P x M)/Y.
C. (Y x M)/P.
D. (Y x M)/V.
11. If Y and V are constant, M doubles, the quantity equation implies that the price level
A. more than doubles.
B. less than doubles.
C. doubles.
D. might do any of the above; more information is needed.
12. If Y and M are constant, V doubles, the quantity equation implies that the price level
A. doubles.
B. less than doubles.
C. more than doubles.
D. might do any of the above; more information is needed.
13. If V and M are constant, Y doubles, the quantity equation implies that the price level
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

A. falls to half its original level.

B. does not change.
C. doubles.
D. more than doubles.
14. If velocity and output were nearly constant,
A. the inflation rate would be much higher than the money supply growth rate.
B. the inflation rate would be about the same as the money supply growth rate.
C. the inflation rate would be much lower than the money supply growth rate.
D. any of the above would be possible.
15. Based on the quantity equation, if M = 100, V = 3, and Y = 200, then P = ?
A. 1
B. 1.5
C. 2
D. None of the above is correct.
16. According to the quantity equation, if P = 12, Y = 6, M= 8, then V = ?
A. 16
B. 9
C. 4
D. None of the above is correct.
17. According to the quantity equation if P = 4 and Y= 800, which of the following pairs
could M and V be?
A. 800; 4
B. 600; 3
C. 400; 2
D. 200; 1
18. If the money supply is $500, real output is $250 units, and the average price of a unit
of real output is $2, the velocity if money is
A. 10
B. 20
C. 30
D. None of the above
19. Last year Tealandia produced 50,000 bags of green tea, which sold at 4 units each of
Tealandia’s currency - the Leaf. Tealandia’s money supply was 10,000. What was the
velocity of money in Tealandia?
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

A. 20
B. 5
C. 1/20
D. 1/5
20. Assuming that V is constant, the quantity equation implies that an increase in M could
result in
A. an increase in the price level.
B. an increase in real GDP.
C. an increase in nominal GDP.
D. any of the above.
21. Interest rates adjusted for the effects of inflation are
A. nominal variables
B. real variables.
C. classical variables.
D. dichotomous variables.
22. The principle of monetary neutrality implies that an increase in the money supply will
A. increase real GDP and the price level.
B. increase real GDP, but not the price level.
C. increase the price level, but not real GDP.
D. increase neither the price level nor real GDP.
23. The velocity of money is
A. the rate at which the central bank puts money into the economy.
B. the same thing as the long-term growth rate of the money supply.
C. the money supply divided by nominal GDP.
D. the average number of times per year a money unit is spent.
24. 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.
25. When deciding how much to save, people care most about
A. after-tax nominal interest rates.
B. after-tax real interest rates.
C. before-tax real interest rates.
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

D. before-tax nominal interest rates.

26. Which of the following inflation costs matter even if actual inflation and expected
inflation are the same?
A. menu costs
B. inflation tax
C. shoeleather costs
D. All of the above are correct.
27. Wealth is distributed from debtors to creditors when inflation is
A. high, but expected.
B. low, but expected.
C. unexpectedly high.
D. unexpectedly low.
28. If the nominal interest rate is 7 percent and the inflation rate is 3 percent, then the
real interest rate is
A. 4 percent.
B. 10 percent.
C. 3 percent.
D. 21 percent.
29. Which of the following statements is correct?
A. The nominal interest rate is the inflation rate minus the real interest rate.
B. The real interest rate is the nominal interest rate minus the inflation rate.
C. The nominal interest rate is the real interest rate minus the inflation rate.
D. The real interest rate is the sum of the nominal interest rate and the inflation rate.
30. If inflation is 8 percent and the real interest rate is 3 percent, then the nominal interest
rate must be
A. 5 percent.
B. 11 percent.
C. 24 percent.
D. -5 percent.
31. Under which of the following conditions would you prefer to be the lender?
A. The nominal rate of interest is 15 percent and the inflation rate is 14 percent.
B. The nominal rate of interest is 25 percent and the inflation rate is 20 percent.
C. The nominal rate of interest is 12 percent and the inflation rate is 9 percent.
D. The nominal rate of interest is 5 percent and the inflation rate is 1 percent.
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

32. Under which of the following conditions would you prefer to be the borrower?
A. The nominal rate of interest is 12 percent and the inflation rate is 9 percent.
B. The nominal rate of interest is 25 percent and the inflation rate is 20 percent.
C. The nominal rate of interest is 5 percent and the inflation rate is 1 percent.
D. The nominal rate of interest is 15 percent and the inflation rate is 14 percent.
33. If borrowers and lenders agree on a nominal interest rate and inflation turns out to
be less than they had expected,
A. neither borrowers nor lenders will gain because the nominal interest rate has been fixed
by contract.
B. borrowers will gain at the expense of lenders.
C. lenders will gain at the expense of borrowers.
D. none of these answers
34. If workers and firms agree on an increase in wages based on their expectations of
inflation and inflation turns out to be more than they expected,
A. workers will gain at the expense of firms.
B. firms will gain at the expense of workers.
C. neither workers nor firms will gain because the increase in wages is fixed in the labour
agreement.
D. none of these answers
35. If actual inflation turns out to be greater than people had expected, then
A. no redistribution occurred.
B. the real interest rate is unaffected.
C. wealth was redistributed to lenders from borrowers.
D. wealth was redistributed to borrowers from lenders.
36. Which of the following costs of inflation does not occur when inflation is constant and
predictable?
A. Shoeleather costs.
B. Menu costs.
C. Costs due to confusion and inconvenience.
D. Arbitrary redistributions of wealth.
37. The shoeleather cost of inflation refers to
A. the fall in real income associated with inflation.
B. the time spent searching for low prices when inflation rises.
C. the waste of resources used to maintain lower money holdings.
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

D. the increased cost to the government of printing more money.

38. Shoeleather costs refer to
A. the cost of more frequent price changes induced by higher inflation.
B. resources used to maintain lower money holdings when inflation is high.
C. the distortion in incentives created by inflation by taxes that do not adjust for inflation.
D. the distortion in resource allocation created by distortions in relative prices due to
inflation.
39. When people use more resources to reduce their money holdings because of high
inflation, this is an example of
A. menu costs.
B. shoeleather costs.
C. inflation-induced tax distortions.
D. relative-price variability costs.
40. The cost of changing price tags and price listings is known as
A. menu costs.
B. shoeleather costs.
C. inflation-induced tax distortions.
D. relative-price variability costs.
41. Menu costs refers to
A. resources used by people to maintain lower money holdings when inflation is high.
B. the distortion in resource allocation created by uncertainty concerning relative price
changes created by inflation.
C. the distortion in incentives created by inflation when taxes do not adjust for inflation.
D. the cost of more frequent price changes induced by higher inflation.
42. Suppose that, because of inflation, a business in Russia must calculate, print, and mail
a new price list to its customers each month. This is an example of
A. shoeleather costs.
B. costs due to confusion and inconvenience.
C. costs due to inflation induced tax distortions.
D. menu costs.
43. Suppose that, because of inflation, people in Brazil economize on currency and go to
the bank each day to withdraw their daily currency needs. This is an example of
A. menu costs.
B. shoeleather costs.
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

C. costs due to inflation induced tax distortions.

D. costs due to confusion and inconvenience.
44. Which of the following statements is true about a situation where real incomes are
rising at 3 percent per year.
A. If money is neutral, an increase in the money supply will not alter the rate of growth of
real income.
B. If inflation were 0 percent, people should receive raises of about 3 percent.
C. If inflation were 5 percent, people should receive raises of about 8 percent per year.
D. All of these answers are true.
45. Adverse supply shock is the change in economy which
A. Shift short run aggregate supply curve to the left, increase inflation rate and decrease
unemployment rate
B. Shift short run aggregate supply curve to the left, decrease inflation rate and increase
unemployment rate
C. Shift short run aggregate supply curve to the left and simultaneously increase both
inflation rate and unemployment rate
D. Shift short run aggregate supply curve to the left and simultaneously decrease both
inflation rate and unemployment rate
46. When demand pull inflation occurs then
A. Unemployment rate declines, inflation rate declines
B. Unemployment rate rises, inflation rate rises
C. Unemployment rate declines, inflation rate rises
D. Unemployment rate rises, inflation rate declines
47. When cost push inflation occurs then
A. Unemployment rate declines, inflation rate declines
B. Unemployment rate rises, inflation rate rises
C. Unemployment rate declines, inflation rate rises
D. Unemployment rate rises, inflation rate declines
48. According to Phillips curve model, the decrease of natural unemployment rate in the
short run will cause
A. The upward move to the left along a Phillips curve
B. The downward move to the right along a Phillips curve
C. The upward shift to a higher Phillips curve
D. The downward shift to a lower Phillips curve
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PRINCIPLE OF MACROECONOMICS INSTRUCTOR: NGUYEN VIET HOA (0378418749)

49. According to Phillips curve model, when firms expect the inflation rate is lower, then
in short run
A. Phillips curve shift outward
B. Phillips curve shift rightward
C. Phillips curve shift inward
D. Phillips curve stays the same
50. An increase in the oil price will lead to
A. The upward move to the left of the economy along a short-run Phillips curve
B. The downward move to the right of the economy along a short-run Phillips curve
C. The upward shift of the economy to a higher short-run Phillips curve
D. The downward shift of the economy to a lower short-run Phillips curve
51. Beneficial supply shock will lead to
A. The upward move to the left of the economy along a short-run Phillips curve
B. The downward move to the right of the economy along a short-run Phillips curve
C. The upward shift of the economy to a higher short-run Phillips curve
D. The downward shift of the economy to a lower short-run Phillips curve
52. Expansionary fiscal policy will lead to
A. The upward move to the left of the economy along a short-run Phillips curve
B. The downward move to the right of the economy along a short-run Phillips curve
C. The upward shift of the economy to a higher short-run Phillips curve
D. The downward shift of the economy to a lower short-run Phillips curve
53. An increase in discount rate will lead to
A. The upward move to the left of the economy along a short-run Phillips curve
B. The downward move to the right of the economy along a short-run Phillips curve
C. The upward shift of the economy to a higher short-run Phillips curve
D. The downward shift of the economy to a lower short-run Phillips curve
54. An decline in reserve rate requirement will lead to
A. The upward move to the left of the economy along a short-run Phillips curve
B. The downward move to the right of the economy along a short-run Phillips curve
C. The upward shift of the economy to a higher short-run Phillips curve
D. The downward shift of the economy to a lower short-run Phillips curve
55. Short-run Phillips curve will shift upward when
A. Benefical supply shock occurs
B. Expected inflation rate increases
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C. Natural unemployment rate decreases

D. All of the above are correct
56. If the economy is facing with both inflation and unemployment problems, when
Phillips curve is very inelastic (steep), policymakers should
A. Increase government spending
B. Inscrease tax
C. Increase transfer payment
D. Both A and C are correct
57. If the economy is facing with both inflation and unemployment problems, when
Phillips curve is very elastic (flat), policymakers should
A. Increase money supply
B. Increase interest rate
C. Both A and B are correct
D. Both A and B are incorrect
58. In the long-run, Phillips curve is
A. Vertical
B. Horizontal
C. Upward sloping
D. Downward sloping
59. Long-run Phillips curve will shift rightward when
A. Benefical supply shock occurs
B. Expected inflation rate increases
C. Natural rate of unemployment increases
D. All of the above are correct
60. If the before-tax real interest rate is 4%, inflation rate is 6 percent, tax rate is 10%
then the after-tax real interest rate is
A. 1% C. 3%
B. 2% D. 4%
PART 2: EXERCISES
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 rate is 1 percent.
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