CHAPTER 11.docx - CHAPTER 11 MONEY GROWTH AND INFLATION Explain how an increase in the price level affects the real value of money(1a According to the

CHAPTER 11.docx - CHAPTER 11 MONEY GROWTH AND INFLATION...

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CHAPTER 11: MONEY GROWTH AND INFLATION - Explain how an increase in the price level affects the real value of money (1a) - According to the quantity theory of money, what is the effect of an increase in the quantity of money. (1b) - Explain the difference between nominal and real variables and give two examples of each. According to the principle of monetary neutrality, which variables are affected by changes in the quantity of money? - In what sense is inflation like a tax? How does thinking about inflation as a tax help explain hyperinflation? - According to the Fisher effect, how does an increase in the inflation rate affect the real interest rate and the nominal interest rate? - What are the costs of inflation? Which of these costs do you think are most important for the Canadian economy? - If inflation is less than expected, who benefits—debtors or creditors? Explain. THE CLASSICAL THEORY OF INFLATION - Explain how an increase in the price level affects the real value of money. a) The Level of Prices and the Value of Money o When the overall price level rises, the value of money falls. o Price Level = P o Value of money = 1/P b) Money Supply, Money Demand, and Monetary Equilibrium The supply and demand for money determines the value of money, Money Supply: the banking system determines the supply of money (refer to previous chapter). o Overnight rates: increase in overnight rates reduces the quantity of money in the reserves = reducing the money supply. Decreasing overnight rates increases the quantity of money in the reserves, increasing the money supply. o Bonds: selling bonds decreases the money supply. Buying bonds increases the money supply. Money Demand: is determined by how much money people want to hold in liquid form at all times. o Average level of prices: If the prices used to buy items are high people will want to keep more money in their wallets, the money demand will increase. [Higher Price Level = Increase the Money Demanded] What ensures that the supply and demand balance in the Long-Run? o The overall level of prices adjusts to the level at which the demand for money equals the supply. Figure 11.1 How the Supply and Demand for Money Determine the Equilibrium Price Level.
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