Question

For each of the following separate situations, determine the associated cost of inflation.

(1) shoe-leather costs; (2) money illusion; (3) menu costs; (4) future price level uncertainty; (5) wealth redistribution; (6) price confusion; or (7) tax distortions.

(Explanations are not required)

1. Wages of computer scientists always rise because our economy needs more and more computer scientist over time.
2. A grandpa talked to his grandson, “When I was young, everything was so cheap. Now everything is too expensive.”
3. Mary does not want to lend money to Simon even though Simon will pay her an interest rate of 3% per year.
4. Tom does not like withdrawing money from an ATM as he always forgets the password.
5. Frankie can make a huge gain if she sells her house, but she is not willing to do so.
6. Carlos sells pizzas. He has kept the prices constant for 3 years even though CPI has been increasing tremendously.

Answer 1

The appropriate categories are as under:

Situation	Cost
Wages of computer scientists always rise because our economy needs more and more computer scientist over time.	wealth redistribution
A grandpa talked to his grandson, “When I was young, everything was so cheap. Now everything is too expensive.”	money illusion
Mary does not want to lend money to Simon even though Simon will pay her an interest rate of 3% per year.	price confusion
Tom does not like withdrawing money from an ATM as he always forgets the password.	shoe-leather costs
Frankie can make a huge gain if she sells her house, but she is not willing to do so.	future price level uncertainty
Carlos sells pizzas. He has kept the prices constant for 3 years even though CPI has been increasing tremendously.	menu costs

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As wages in one profession rise, they fall in other professions. This is redistribution of wealth.

The grandpa is facing a typical "money illusion", by comparing just nominal prices.

Mary is facing price confusion as she doesn't know the future inflation.

Tom would not like to face shoe-leather costs of going to the ATM too often.

Frankie is uncertain about the future prices in the housing market.

Carlos will have to incur a lot of menu costs if he keeps changing the prices.