Macro Ch. 17

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If P represents the price of goods and services measured in terms of money, then

-P can be regarded as the "overall price level." -an increase in the value of money is associated with a decrease in P. -1/P represents the value of money measured in terms of goods and services.

we study the quantity theory of money using two approaches

1. a supply-demand diagram 2. an equation

if P is the price level, then the quantity of goods and service that can be purchased with $1 is equal to

1/P (1/P is the value of $1, measured in goods) EX. basket contains one candy bar if P=$2, value of $1 is 1/2 candy bar if P=$3, value of $1 is 1/3 candy bar

hyperinflation

defined as inflation exceeding 50% per month -excessive growth in they money supply always causes hyperinflation

inflation drives up prices, and

drives down the value of money

a rise in the price level also means that the value of money is now lower because

each dollar now buys a smaller quantity of goods and services (price level as a measure of the value of money)

Printing money to finance government expenditures

imposes a tax on everyone who holds money.

money supply (MS)

in real world, determined by ferderal reserve, the banking system, and consumers

for the money-supply demand a fall in value of money (or increase in P)

increase the quantity of money demanded

a relative price

is the price of one good relative to (divided by) another. -Relative price of CDs in terms of pizza price of CD/price of pizza

The Fisher effect says that

the nominal interest rate adjusts one for one with the inflation rate.

P=the price level (e.g., the CPI of GDP deflator) is

the price of basket goods, measured in money

monetary neutrality

the proposition that changes in the money supply do not affect the real variables

velocity of money

the rate at which money changes hands or the average number of times per year a dollar is spent

shoeleather costs

the resources wasted when inflation encourages people to reduce their money holdings

classical dichotomy

the theoretical separation of nominal and real variables

the inflation fallacy

where most people think inflation gradually destroys real incomes

For money supply P adjusts to equate quantity of money demanded

with money supply

The term hyperinflation refers to

a period of very high inflation.

The classical dichotomy argues that changes in the money supply

affect nominal variables, but not real variables.

nominal variables

are measured in monetary units EX. nominal GDP, the dollar value of the economy's output of final goods and services

real variables

are measured in physical units. EX. real GDP, real wages (measured in output)

According to the quantity theory of money, a 2 percent increase in the money supply

causes the price level to rise by 2 percent.

If the economy unexpectedly went from inflation to deflation,

creditors would gain at the expense of debtors.

Price rises when

the gov. prints too much money

most economists believe the classical dichotomy and neutrality of money describe the economy in the

long run

quantity theory of money developed by the 18th century philosopher and the classical economists

milton friedman

quantity of money demanded is ______ related to the value of money and _______ related to P, other things equal

negatively positively

Most economists believe the quantity theory is a good explanation

of the long run behavior of inflation

when the price level rises

people have to pay more for goods and services that they purchase (price level as the price of a basket of goods and services)

Economic variables whose values are measured in goods are called

real variables.

for money demand (MD) an increase in P

reduces the value of money

the fed sets MS at some fixed value

regardless of P

The value of money falls as the price level

rises, because the number of dollars needed to buy a representative basket of goods rises

hume and the classical economists

suggested the monetary developments affect nominal variables but not real variables

The supply of money is determined by

the Federal Reserve System.


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