Question

4. Suppose that people expect inflation to equal 3 percent, but in fact, prices rise by 5 percent. Indicate whether this unexpected higher rate of inflation would help or hurt each of the following groups.

• 1. a homeowner with a fixed-rate mortgage.
  2. a union worker with a fixed labour contract
  3. a company that has invested some of its endowment in government bonds which pays a fixed rate of return.

5. Indicate how each of the following events would affect the aggregate demand AD curve:

• 1. a short-run decrease in the price level
  2. an increase in consumer confidence on the price level and real GDP
  3. an increase in government purchases

Answer 1

4) Given that people expect rate of inflation as 3 % but the price increases by 5%. Lets have a look at how this might impact on the following

• a homeowner with a fixed-rate mortgage will have a positive impact. This means that it helps these groups as inflation as 3% and price increases to 5%. This is because the interest rate depends only on inflation.
• a union worker with a fixed labour contract gets hurt because the worker will receive lesser real wage due to inflation.
• a company that has invested some of its endowment in government bonds which pays a fixed rate of return gets hurt. This is because the increase in inflation causes a lesser interest rate to be gained.

5) Lets see how the following events would affect the aggregate demand AD curve

• A short-run decrease in the price level will impact downward movement along the AD curve since price level and quantity are inversely proportional. that means AD is downward slopping.
• An increase in consumer confidence on the price level and real GDP, spending will increase. Hence the AD will increase and this shows a right shift in AD curve.
• an increase in government purchases motivates employment rate to increase hence income rises. Then the AD shifts right as AD increases.

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