Question

2. Suppose that changes in bank regulations expand the availability of credit cards, so that people need to hold less cash. a. How does this event affect the demand for money? b. If the central bank does not respond to this event, what will happen to the price level? c. If the central bank wants to keep the price level stable, what should it do?
13. Explain whether the following statements are true, false, or uncertain. a. "Inflation hurts borrowers and helps lenders, because borrowers must pay a higher rate of interest." b. "If prices change in a way that leaves the overall price level unchanged, then no one is made better or worse off." c. "Inflation does not reduce the purchasing power of most workers."

Answer 1

2. First of all, we should understand that credit card is more similar to a loan which is agreed to be paid on a future date. According to the definition, demand for money is the sum total of money you have in your wallet and bank account (many economists argue that it would also include assets that are easily liquifiable. Let's keep to the wallet and bank account for simplicity ). Said that we move on to the questions.

A. Demand for money will decrease in short run since people will prefer to have less cash holdings since they are borrowing it.

B. Keeping other things constant and Central Bank not responding, price level is likely to increase due to increased purchasing power in people's hand. Along with the money in hand credit cards offer an extra more to buy more goods than before. Increased demand for goods will increase the general price level (inflation) because supply cannot be increased in short run.

C. An inflation between 2 to 4 percent is always recommended for a healthy economy. The Central Bank should closely monitor the price level and if it is increasing more than expected harming the economy, money supply should be reduced. There are many ways to go about this, central bank can increase the interest rate, ask banks to increase their reserves and many more. Since this situation is due to excess credit cards usage( in this question) Central Bank could impose restrictions on credit cards availability and usage.

13. A.

False, inflation affects lenders more since the value of money decrease due to inflation. Only the nominal interest rate is increasing not the real interest rate.

Suppose you lend someone $1000. You could 1000 chocolates for that 1000 dollars. Ten years from now with 10% increase in price level that exact 1000 chocolates will cost you $1100. The the borrower will only be paying you the same $1000. Now look at the interest rate. Borrower is supposed to pay 10 dollars in interest (10 chocolate) suppose interest rate increased 10% to 11 dollars in the 10th year. Still you are only getting 10 chocaltes for that 11 dollar he pays. Guess who is loosing?

B. False, the effects cannot be distributed equally. Some will be better of like the borrower and some will be worse of like the lender.

C. It is true to an great extent because with increased inflation nominal wages are often increased so that real wages remains same.

You still get the same number of chocolates with increased wages due to inflation.