Macroeconomics
Macroeconomics
5th Edition
ISBN: 9781319098759
Author: Paul Krugman, Robin Wells
Publisher: Worth Publishers
Question
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Chapter 16, Problem 4P
To determine

Concept Introduction:

Deflation: When the average price level decreases continuously for a given interval in an economy then it is referred as deflation. It leads to a recession in an economy. Deflation is not healthy for an economy.

Inflation: When the price of any good increases continuously for an interval of time it is called inflation. It leads to a decrease in the purchasing power. A controlled inflation is good for an economy.

Hyper-inflation: When the inflation rate is very high and is usually for a longer duration then it is termed as hyper-inflation. It has a very harsh impact on an economy as it leads to depression.

Inflation Tax: It is a tax which is bared by the asset or the income holders due to an increase in the rate of inflation. It is a kind of capital gain tax resulting due to a rise in the price.

The formula to calculate inflation tax is,

    InflationTax=RateofInflation×AmountofMoney

Expert Solution & Answer
Check Mark

Explanation of Solution

a. Real inflation tax paid by Ms. Maria

Given,

Amount hold in stock is $1,000.

Rate of inflation is 10%.

The formula to calculate inflation tax is,

    InflationTax=RateofInflation×AmountofMoney

Substitute $1,000 for the amount of money and 10% for the rate of inflation.

    InflationTax=10%×$1,000=10100×$1,000=$100

The real value of inflation tax paid by Ms. Maria is $100.

b. Real inflation tax paid by Ms. Maria for the second year.

Given,

Amount at the beginning of the second year is $900.

Rate of inflation after two years is 10.1%.

The formula to calculate inflation tax is,

    InflationTax=RateofInflation×AmountofMoney

Substitute $900 for the amount of money and 10.1% for the rate of inflation.

    InflationTax=10.1%×$900=10.1100×$900=$90.9

The real value of inflation tax paid by Ms. Maria for the second year is $90.9.

c. Real inflation tax paid by Mrs. Maria for the third year.

Given,

Amount at the beginning of the third year is $809.1.

Rate of inflation after three years is 10.21%.

The formula to calculate inflation tax is,

    InflationTax=RateofInflation×AmountofMoney

Substitute $809.1 for the amount of money and 10.21% for the rate of inflation.

    InflationTax=10.21%×$809.1=10.21100×$809.1=$82.6

The real value of inflation tax paid by Mrs. Maria for the third year is $82.6.

d. Cumulative real inflation tax paid.

Given,

Tax for the first year is $100.

Tax for the second year is $90.9.

Tax for the third year is $82.6.

The formula to calculate cumulative inflation tax paid is,

    CumulativeRealInflationTax=(TaxForFirstYear+TaxForSecondYear+TaxForThirdYear)

Substitute $100 for the tax for the first year, $90.9 for the tax for the second year and $82.6 for the tax for the third year.

    CumulativeRealInflationTax=$100+$90.9+$82.6=$273.5

The cumulative inflation tax paid is $273.5.

e. Inflation tax when the inflation rate is 25%.

Real inflation tax for the first year

Given,

Amount hold in stock is $1,000.

Rate of inflation is 25%.

The formula to calculate inflation tax is,

    InflationTax=RateofInflation×AmountofMoney

Substitute $1,000 for the amount of money and 25% for the rate of inflation.

    InflationTax=25%×$1,000=25100×$1,000=$250

The real value of inflation tax paid by Mrs. Maria is $250.

Real inflation tax for the second year.

Given,

Amount at the beginning of the second year is $750.

Rate of inflation after two years is 25.25%

The formula to calculate inflation tax is,

    InflationTax=RateofInflation×AmountofMoney

Substitute $750 for the amount of money and 25.25% for the rate of inflation.

    InflationTax=25.25%×$750=25.25100×$750=$189.375

The real value of inflation tax paid by Mrs. Maria for the second year is $189.375.

Real inflation tax for the third year.

Given,

Amount at the beginning of the third year is $560.625.

Rate of inflation after three years is 25.525%

Hyper-inflation is such a big problem because it leads to a large amount of inflation tax. The purchasing power of money decreases which certainly leads to an instability in the market.

The formula to calculate inflation tax is,

    InflationTax=RateofInflation×AmountofMoney

Substitute $560.625 for the amount of money and 25.525% for the rate of inflation.

    InflationTax=25.525%×$560.625=25.525100×$560.625=$143.09

The real value of the inflation tax paid for the third year is $143.09.

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