Check Your Understanding

1. Question

   Explain why a large increase in the money supply causes a larger short-run increase in real GDP in an economy that previously had low inflation than in an economy that previously had high inflation. What does this say about situations in which the classical model of the price level applies?

2. Question

   Suppose that all wages and prices in an economy are indexed to inflation, meaning that they increase at the same rate as the price level. Can there still be an inflation tax?