Chapter 5: Quiz Answers -- Inflation

1. Stabilization policy includes all the following goals except:
   bring unemployment down to as low of a rate as possible. Inflation and unemployment tend to be inversely related. If unemployment is reduced to very low levels, inflation is likely to increase.

2. The CPI is
   all of the above.

3. Suppose you have selected a bundle of goods and services to track over time. The base year is 1995, and the cost of the bundle in the base year is $400. In 1996, the cost of the bundle was $412. The price indices in 1995 and 1996 are, respectively,
   100, 103. The price index in the base year (1995) is 100 by definition. To calculate the price index in 1996, we take 412/400 = 103.

4. Suppose the CPI value for 1996 is 150, and the CPI value for 1997 is 155. Given this the inflation rate for 1997 is
   3.33%. The inflation rate is (155 - 150)/150 * 100 = 3.33%

5. Again, suppose the CPI in 1996 is 150, and the CPI in 1997 is 155. If a meal at McDonalds cost $4 in 1996 but the same meal costs $4.50 in 1997, in which year is the McDonalds meal cheaper in real terms?
   1996. This problem requires you to deflate the nominal prices into real prices. The meal in 1996, which costs $4, has a "real" price of $4/150*100 = $2.67. The meal in 1997 in real terms is $4.50/155*100 = $2.90. The meal, therefore, is cheaper in 1996.

6. The inflation rates in the United States since 1983 have generally been
   under 4 percent. The Bureau of Labor Statistics tracks inflation statistics. Except for one or two years in the late 1980s, the annual inflation rate has been under 4 percent.

7. The main reason that we deflate nominals to reals is to
   make meaningful comparisons of the prices of goods and services across years. Otherwise, how would we know, for example, how much gasoline cost in the year 2001 relative to the year 1991?

8. An example of the costs from unanticipated inflation is
   Jerry receives a raise of 3 percent, but finds that inflation has risen 6 percent. The other answers are very real costs of inflation, but they are costs from anticipated inflation. Even if Betty, Sarah and Gary knew that inflation was coming and they perfectly predicted the inflation rate, the costs imposed on them would not have changed. Jerry, however, likely would have asked for a larger raise.

9. Since 1973, real wages have hardly increased because nominal wage gains have barely kept up with inflation. But before 1973, it was more common for wage gains to exceed inflation.
   True. Unfortunately, this is an accurate statement. Real wages have increased more since the late 1990s due to higher productivity growth, but larger gains were made before 1973.

10. The inflation due to the oil shocks of the mid and late 1970s can be classified as demand-pull inflation.
    False. This supply-side inflation is knows as cost-push inflation.