Question

You are a union worker and are employed under a contract that freezes your wages for the next three years. Today, you read an article stating the rate of inflation will increase significantly in the next few years due to a rapidly growing money supply.

What two changes are you most likely to experience?

a. Your $500 grocery budget will pay for more groceries than before.

b. Your $500 grocery budget will pay for less groceries than before.

c. You’ll be able to dine out more on your same $200 entertainment budget.

d. You’ll be able to dine out less on your same $200 entertainment budget. The economy has been growing rapidly and inflation is spiraling out of control. Which of the following two scenarios regarding money supply would best reflect Fed attempts to control spiraling inflation? a. Before Fed Action M1 - $3 trillion, After Fed Action M1 - $3.5 trillion b. Before Fed Action M1 - $3 trillion, After Fed Action M1 - $2.5 trillion c. Before Fed Action M1 - $22 trillion, After Fed Action M1 - $24 trillion d. Before Fed Action M1 - $322 trillion, After Fed Action M1 - $20 trillion Several years ago you retired on a fixed pension. After you did, economic activity increased slightly. The rate of inflation remained low. Recently though, economic activity has increased dramatically, causing inflation to spike. As a concerned citizen, you are writing a letter to the Chairman of the Federal Reserve Bank to advocate a change in economic policy that would slow the rate of inflation. Which two options below will you recommend in your letter? a. Decrease the bank reserve requirement b. Decrease the discount rate c. Increase the bank reserve requirement d. Buy government securities e. Increase the discount rate

Answer 1

Answer:

1. You are a union worker and are employed under a contract that freezes your wages for the next three years. Today, you read an article stating the rate of inflation will increase significantly in the next few years due to a rapidly growing money supply.

What two changes are you most likely to experience?

Answer 1:

The two changes that are most likely to be experienced are:

b. Your $500 grocery budget will pay for less grocery than before.

d. You’ll be able to dine out less on your same $200 entertainment budget.

Since increase in money supply increases the price level of the commodities and at the same time the spending capacity of the consumer increases. Since the price of the product increases, $ 500 grocery budget will pay for less grocery than before and you’ll be able to dine out less on your same $200 entertainment budget.

2. The economy has been growing rapidly and inflation is spiralling out of control. Which of the following two scenarios regarding money supply would best reflect Fed attempts to control spiralling inflation?

Answer 2:

Following two scenarios regarding money supply would best reflect Fed attempts to control spiralling inflation

b. Before Fed Action M1 - $3 trillion, After Fed Action M1 - $2.5 trillion

d. Before Fed Action M1 - $322 trillion, After Fed Action M1 - $20 trillion

Spiralling of inflation out of control means that the inflation is growing at a very high rate and it is needed to stop. In order to stop the spiralling of inflation out of control, Fed will implement the tightening policy of the money supply wherein it will slow down or stop the money supply in the economy..

3. Several years ago you retired on a fixed pension. After you did, economic activity increased slightly. The rate of inflation remained low. Recently though, economic activity has increased dramatically, causing inflation to spike. As a concerned citizen, you are writing a letter to the Chairman of the Federal Reserve Bank to advocate a change in economic policy that would slow the rate of inflation. Which two options below will you recommend in your letter?

Answer 3:

Following two options below will be recommended in the letter:

c. Increase the bank reserve requirement

Increase in the bank reserve requirement will increase the amount of cash a bank is required to hold resulting into the less money supply in the market as a result of which the inflation rate will be slowed down.

e. Increase the discount rate

Increase in the interest rate reduces the consumer spending and the aggregate demand as the customers are de motivated towards spending the money. This results into lower economic growth and hence the inflation rate gets reduced.