Question

Eleanor spends all of her money on magazines and donuts. In 2014, she earned $14.00 per hour, the price of a magazine was $7.00, and the price of a donut was $1.00.
Which of the following give the nominal value of a variable?
A. Eleanor's wage is $14.00 per hour in 2014.
B. The price of a donut is $1.00 in 2014.
C. Eleanor's wage is 2 magazines per hour in 2014.
Which of the following give the real value of a variable?
A. Eleanor's wage is 14 donuts per hour in 2014.
B. The price of a magazine is 7 donuts in 2014.
C. Eleanor's wage is $14.00 per hour in 2014.
Suppose that the Fed sharply increases the money supply between 2014 and 2019. In 2019, Eleanor's wage has risen to $28.00 per hour. The price of a magazine is $14.00 and the price of a donut is $2.00.
In 2019, the relative price of a magazine is ________.
Between 2014 and 2019, the nominal value of Eleanor'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 variables.

Answer 1

Answer;

1. A. Eleanor's wage is $14.00 per hour in 2014.

B. The price of a donut is $1.00 in 2014.

When a variable is stated in nominal terms, it is usually given as a fixed monetary value because it is not adjusted for inflation. It therefore mentions just the price as is.

2. A. Eleanor's wage is 14 donuts per hour in 2014.

B. The price of a magazine is 7 donuts in 2014.

When goods are described in real terms, they are related to another good in order to adjust them for inflation.

3. The price of a magazine is $14.00 and the price of a donut is $2.00.

In 2019, the relative price of a magazine is 7 donuts.

The relative price = Price of Magazine/ Price of donuts

= 14/2

= 7 donuts.

4.  Between 2014 and 2019, the nominal value of Eleanor's wage increases, and the real value of her wage remains the same.

As a result of the increase in money supply, Eleanor's wages increased nominally from $14 to $28.

However, in real terms her wages did not increase at all because the price level in the economy increased by the same rate that her wages increased meaning that she is still only able to buy the same quantity of things.

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

From Eleanor's example above, the concept of Money Neutrality is shown in that while a change in money supply will affect nominal variables, it will not affect real variables due to a general rise in prices.