Question

3. The classical dichotomy and the neutrality of money

The classical dichotomy is the separation of real and nominal variables. The following questions test your understanding of this distinction.

Dina spends all of her money on comic books and beignets. In 2012, she earned $27.00 per hour, the price of a comic book was $9.00, and the price of a beignet was $3.00.

Which of the following give the nominal value of a variable? Check all that apply.

Dina's wage is 3 comic books per hour in 2012.

The price of a beignet is 0.33 comic books in 2012.

The price of a beignet is $3.00 in 2012.

Which of the following give the real value of a variable? Check all that apply.

Dina's wage is $27.00 per hour in 2012.

The price of a comic book is $9.00 in 2012.

The price of a comic book is 3 beignets in 2012.

Suppose that the Fed sharply increases the money supply between 2012 and 2017. In 2017, Dina's wage has risen to $54.00 per hour. The price of a comic book is $18.00 and the price of a beignet is $6.00.

In 2017, the relative price of a comic book is ______ .

Between 2012 and 2017, the nominal value of Dina's wage ______, and the real value of her wage ______.

Monetary neutrality is the proposition that a change in the money supply ______ nominal variables and ______ real variables.

Answer 1

Nominal value is measured in terms of money while real value is measured against goods and services.

Therefore, the nominal value of a variable is the price of a beignet is $3 in 2012 , Dina's wage is $27 per hour in 2012 , the price of a comic book is $9 in 2012 . Hence, option(C) is correct.

And real value of a variable is the price of a comic book is 3 beignets in 2012 , Dina's wage is 3 comic books per hour in 2012 , the price of beignet is 0.33 comic books in 2012. Hence, option(C) is correct.

In 2017, the relative price of comic books is 18/6 = 3 beignets.

In 2017, the nominal value of Dina's wage = $54 and real wage in 2017 = 54/18 = 3 comic books per hour.

This implies that between 2012 and 2017 , the nominal value of Dina's wage increases and the real value of her wage remains the same.

Monetary neutrality is the proposition that a change in the money supply affects nominal variables and does not affect real variables.