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3. The classical dichotomy and the neutrality of money The classical dichotomy is the separation of...

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.

Amy spends all of her money on paperback novels and mandarins. In 2015, she earned $18.00 per hour, the price of a paperback novel was $9.00, and the price of a mandarin was $1.00.

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

Amy's wage is 2 paperback novels per hour in 2015.

Amy's wage is $18.00 per hour in 2015.

The price of a mandarin is $1.00 in 2015.

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

Amy's wage is $18.00 per hour in 2015.

Amy's wage is 18 mandarins per hour in 2015.

The price of a paperback novel is 9 mandarins in 2015.

Suppose that the Fed sharply increases the money supply between 2015 and 2020. In 2020, Amy's wage has risen to $36.00 per hour. The price of a paperback novel is $18.00 and the price of a mandarin is $2.00.

In 2020, the relative price of a paperback novel is   .

Between 2015 and 2020, the nominal value of Amy'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

Solutions

Expert Solution

Nominal variables are measured in monetary terms.

The following give the nominal value of a variable

  • The price of a mandarian is $1 in 2015
  • Amy;s wage is $18 per hour in 2015.

Answer: Option (B) and (C)

Real variables are measured in physical units.

The following give the real value of a variable.

  • The price of paperback novel is 9 mandarians in 2015
  • Amy's wage is 18 mandarins per hour in 2015

Answer: Option (B) and (C)

In 2020 the price of paperback novel is $18 and price of mandarin is $2.

Relative price of paperback novel = ($18 / $2) = 9 mandarins

In 2020, the relative price of a paperback novel is 9 mandarins.

Real wages = Nominal wage / Price of product.

In 2015

Real wage in terms of paperback novel = ($18 / $9) = 2 paperback novel

Real wage in terms of mandarins = ($18 / $1) = 18 mandarins.

In 2020

Real wage in terms of paperback novel = ($36 / $18) = 2 paperback novel

Real wage in terms of mandarins = ($36 / $2) = 18 mandarins.

Between 2015 and 2020, the nominal value of Amy's wage increases, and the real value of her wage remains the same.

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

Rahul Sunny answered 2 years ago
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