Question

1. Below is a list of potential problems that inflation might cause. Use the space on the left to name each of these with the terms used in chapter 8.
   • ___________ Lenders and workers are reluctant to help firms produce output because the real value of future dollar payoffs is unclear.
   • ___________  Workers make decisions on the basis of nominal rather than real wage changes.
   • ­­­____________ Unexpected inflation reduces the real value of loan repayments.
   • ____________  Firms cannot distinguish whether there is a change in the relative price of their good or a change in the overall price level.
   • _____________Restaurants need to spend resources to alter the prices on their menus.
   • _____________Individuals own stock shares for many years and then sell them and are required to pay taxes on the nominal capital gain.
   • ______________People leave work early to shop before inflation changes prices
2. 
   Costs of Inflation Summary The Costs of Inflation Cost of Inflation Description Shoe-leather costs Time and resources are spent to guard against the effects of inflation. Money illusion Consumers misinterpret nominal changes as real changes. Menu costs Firms incur extra costs to change their output prices. Future price level Long-term agreements may not be signed if lenders, uncertainty firms, and workers are unsure about future price levels. Wealth redistribution Surprise inflation redistributes wealth from lenders to borrowers. Price confusion Inflation makes it difficult to read price signals, and this confusion can lead to a misallocation of resources, Tax distortions Inflation makes capital gains appear larger and thus increases tax burdens. o O 1. Below is a list of potential problems that inflation might cause. Use the space on the left to name each of these with the terms used in chapter 8. 15 points (2pts each, extra point if you get all of them right) Lenders and workers are reluctant to help firms produce output because the real value of future dollar payoffs is unclear. Workers make decisions on the basis of nominal rather than real wage changes. Unexpected inflation reduces the real value of loan repayments. Firms cannot distinguish whether there is a change in the relative price of their good or a change in the overall price level. Restaurants need to spend resources to alter the prices on their menus. _Individuals own stock shares for many years and then sell them and are required to pay taxes on the nominal capital gain. _People leave work early to shop before inflation changes prices 0 O o o
   

Answer 1

(A) Lenders and workers are reluctant to help firms produce output because the real value of future dollar payoffs is unclear - Future price level uncertainty (since lenders are unsure about which future price the borrowers can charge)

(B) Workers make decisions on the basis of nominal rather than real wage changes - Money illusion (since workers are deciding without considering real prices)

­­­(C) Unexpected inflation reduces the real value of loan repayments - Wealth redistribution (since borrowers gain but lenders lose)

(D) Firms cannot distinguish whether there is a change in the relative price of their good or a change in the overall price level - Price Confusion (since firms are uncertain and confused about real prices)

(E) Restaurants need to spend resources to alter the prices on their menus - Menu costs (sellers are spending resources to change menu price)

(F) Individuals own stock shares for many years and then sell them and are required to pay taxes on the nominal capital gain - Tax distortion (since inflation makes this illusion of high capital gains)

(G) People leave work early to shop before inflation changes prices - Shoe-leather costs (people are spending resources to adjust for inflation-caused price level changes)