Question

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.

Maria spends all of her money on paperback novels and donuts. In 2012, she earned $14.00 per hour, the price of a paperback novel was $7.00, and the price of a donut was $2.00.

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

a)The price of a donut is $2.00 in 2012.

b)Maria's wage is 2 paperback novels per hour in 2012.

c)The price of a donut is 0.29 paperback novels in 2012.

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

a)The price of a paperback novel is 3.5 donuts in 2012.

b)Maria's wage is $14.00 per hour in 2012.

c)The price of a paperback novel is $7.00 in 2012.

Suppose that the Fed sharply increases the money supply between 2012 and 2017. In 2017, Maria's wage has risen to $28.00 per hour. The price of a paperback novel is $14.00 and the price of a donut is $4.00.

3) In 2017, the relative price of a paperback novel is (.29 donuts, 3.5 donuts, $4, $14).

4) Between 2012 and 2017, the nominal value of Maria's wage (decreases, increases, remains the same), and the real value of her wage (increases, decreases, remains the same).

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

Answer 1

1) option a)

b & c are in Relative terms, Hence real Variable

2) option. a)

b & c are nominal Variables

3) 3.5 donuts

in 2017 , with $28, number of novels could be bought = 28/14 = 2

Donuts = 28/4 = 7

Thus, 2 novels = 7 donuts

1 novel = 3.5 donuts

4) nominal value of Wage increases from 14 to 28

Real Wage remains same

as buying power in terms of donuts & novels remain same

5) ∆ in money Supply affects nominal Variable

& Doesnt affect real Variable