3. The classical dichotomy and the neutrality of money The classical dichotomy i
ID: 1165086 • Letter: 3
Question
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.
Juanita spends all of her money on comic books and donuts. In 2012, she earned $14.00 per hour, the price of a comic book was $7.00, and the price of a donut was $2.00.
Which of the following give the nominal value of a variable? Check all that apply.
Juanita's wage is 2 comic books per hour in 2012.
The price of a donut is 0.29 comic books in 2012.
The price of a donut is $2.00 in 2012.
Which of the following give the real value of a variable? Check all that apply.
Juanita's wage is $14.00 per hour in 2012.
The price of a comic book is $7.00 in 2012.
The price of a comic book is 3.5 donuts in 2012.
Suppose that the Fed sharply increases the money supply between 2012 and 2017. In 2017, Juanita's wage has risen to $28.00 per hour. The price of a comic book is $14.00 and the price of a donut is $4.00.
In 2017, the relative price of a comic book is .
Between 2012 and 2017, the nominal value of Juanita'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.
Explanation / Answer
1-Answer is I
it is a nominal value because first option talks in absolute terms the wage rate of Juanita.
2-Answer is I
it is the real value because first option tells the value of wage relative to donuts it is the amount of donuts that can be bought with the money. Since it tells the purchasing power.
3-In 2017 relative price of comic book is the amount of donuts that could be bought in it's place which is = 14/2 = 7 Donuts
nominal value Juanita's wage has increased (from $14 to $28). As told above, real values are found after adjusting for price. In 2017 the prices are 2x the prices in 2012, so the general price level has increased 2 times. Also, the wage has increased 2 times.
Real value of wage (in 2012) = nominal value of wage in 2012/nominal value of price in 2012.
Real value of wage (in 2017) = nominal valueof wage in 2017/price level in 2017 = (2*initial nominal value(in 2012))/(2*initial price level(in 2012)) = nominal value of wage in 2012/nominal value of price in 2012.
So, real value of wage in 2012 = real value of wage in 2017, or in other terms, the real value of her wage has remained same (not changed).
This is the concept of money neutrality. It is the proposition that a change in the money supply changes (in our example, increased) nominal variables, and doesn't change real variables.
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