HW2_sol - 26 Answers to Textbook Questions and Problems...

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have produced a larger total quantity of goods and services, valued in base-year dollars. As another example, the real interest rate measures the increase in your purchasing power, the quantity of goods and services you can buy with your dollars, while the nom- inal interest rate measures the increase in the amount of current dollars you possess. The interest rate you are quoted by your bank, say 3 percent, is a nominal rate. If the inflation rate is 3 percent, then the real interest rate is 5 percent, meaning your pur- chasing power has only increased by 5 percent and not 8 percent. The quantity of dol- lars you possess has increased by 8 percent but you can only afford to buy 5 percent more goods and services with these dollars. Problems and Applications 1. Money functions as a store of value, a medium of exchange, and a unit of account. a. A credit card can serve as a medium of exchange because it is accepted in exchange for goods and services. A credit card is, arguably, a (negative) store of value because you can accumulate debt with it. A credit card is not a unit of account—a car, for example, does not cost 5 VISA cards. b. A Rembrandt painting is a store of value only. c. A subway token, within the subway system, satisfies all three functions of money. Yet outside the subway system, it is not widely used as a unit of account or a medium of exchange, so it is not a form of money. 2. The real interest rate is the difference between the nominal interest rate and the infla- tion rate. The nominal interest rate is 11 percent, but we need to solve for the inflation rate. We do this with the quantity equation expressed in percentage-change form: % Change in M + % Change in V = % Change in P + % Change in Y.
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HW2_sol - 26 Answers to Textbook Questions and Problems...

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