Money Supply Problems and Solutions

Money Supply Problems and Solutions - Candidate Answers...

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Candidate Answers Homework #7 ECON 402 – Spring 2014 1. Please read: The Economic Organisation of a P.O.W. Camp; R. A. Radford; Economica , New Series, Vol. 12, No. 48. (Nov., 1945), pp. 189-201. A PDF version of the article is linked on my webpage; you can also do a web search – there are copies all over the place. The prisoner-of-war camp described by Radford periodically received large shipments of cigarettes from the Red Cross or other sources. a. How did cigarette shipments affect the price level (the prices of goods in terms of cigarettes) in the POW camp? New cigarettes equate to a higher nominal money supply. With no corresponding change in real money demand, the equilibrium price level must rise. Conceptually, you have more cigarettes being used in the same number of transactions as before the shipment arrival. b. On some occasions the prisoners knew in advance when the cigarette shipments were to arrive. What happened to the demand for cigarette money and the price level in the camp in the days just before an anticipated shipment? If there is an anticipated shipment, then prices are expected to increase (i.e., expected inflation is positive, albeit briefly, at some point in the future). At the time of the shipment POW’s want to possess fewer cigarettes for transactions purposes – their real money demand is reduced. But the real demand for money goes down today in anticipation of lower desired cigarette holdings later. With a fixed supply of cigarettes, prices will increase today. Conceptually, prisoners accelerate their purchases so as to end up with fewer devalued cigarettes; this spike in demand drives prices up.
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