Principles of Economics- Mankiw (5th) 609

Principles of Economics- Mankiw (5th) 609 - that, over...

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CHAPTER 28 MONEY GROWTH AND INFLATION 629 THE CLASSICAL THEORY OF INFLATION We begin our study of inflation by developing the quantity theory of money. This theory is often called “classical” because it was developed by some of the earliest thinkers about economic issues. Most economists today rely on this theory to ex- plain the long-run determinants of the price level and the inflation rate. THE LEVEL OF PRICES AND THE VALUE OF MONEY Suppose we observe over some period of time the price of an ice-cream cone rising from a nickel to a dollar. What conclusion should we draw from the fact that peo- ple are willing to give up so much more money in exchange for a cone? It is possi- ble that people have come to enjoy ice cream more (perhaps because some chemist has developed a miraculous new flavor). Yet that is probably not the case. It is more likely that people’s enjoyment of ice cream has stayed roughly the same and
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Unformatted text preview: that, over time, the money used to buy ice cream has become less valuable. Indeed, the first insight about inflation is that it is more about the value of money than about the value of goods. This insight helps point the way toward a theory of inflation. When the con-sumer price index and other measures of the price level rise, commentators are often tempted to look at the many individual prices that make up these price indexes: The CPI rose by 3 percent last month, led by a 20 percent rise in the price of coffee and a 30 percent rise in the price of heating oil. Although this ap-proach does contain some interesting information about whats happening in the So whats it going to be? The same size as last year or the same price as last year?...
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