Macro Ch. 17
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.