In: Economics
1. Which of the following is an example of someone who is experiencing money illusion?
A) The CPI in an economy has increased by 2.3%, and Paul's nominal wage is increased by 2.3%.
B) The CPI in an economy has decreased by 5%, but Vivian will not accept lower nominal wages because she believes this is unfair.
C) Prices have not changed in the economy, so your boss does not give you a raise.
D) Darren sees that prices in the economy have risen by 2% and that the nominal interest rate on his savings account rose 0.5%. So Darren knows he is experiencing a 1.5% decrease in his real interest earnings.
2. Suppose that an economy is in a recession. You would expect to see the unemployment rate:
A) rise above the equilibrium unemployment rate.
B) fall below the equilibrium unemployment rate.
C) be zero.
D) be equal to the equilibrium unemployment rate.
3. If expected inflation is 3% and actual inflation is 4.2%, then unexpected inflation is:
A) 3.0%.
B) 7.2%.
C) 1.2%.
D) 4.2%.
Answer Option D) Darren sees that prices in the economy have risen by 2% and that the nominal interest rate on his savings account rose 0.5%. So Darren knows he is experiencing a 1.5% decrease in his real interest earnings.
It is an example of money illusion. Money illusion is a concept in which consumers only worried about their nominal money rather than real money adjusted for inflation. The opportunity is taken by the employers and employers increase minor nominal wages without paying more in real terms.
Answer Option -A) Rise above the equilibrium unemployment rate.
The reason is that during inflation, aggregate demand and aggregate supply will decrease and unemployment will increase. Therefore, unemployment will rise above the equilibrium unemployment rate.
Answer Option C) 1.2 %
If expected inflation is 3% and actual inflation is 4.2%
Actual inflation - expected inflation = Unexpected inflation
4.2-3=1.2
Unexpected inflation= 1.2%