Chapter 4 student

Chapter 4 student - Money and Inflation An economist is someone who knows the price of everything and the value of nothing Topics and Concepts The

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Money and Inflation An economist is someone who knows the price of everything and the value of nothing.
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Topics and Concepts • The classical theory of inflation – causes – effects – social costs • “Classical” – assumes prices are flexible & markets clear • Applies to the long run
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Inflation and its trend, 1960-2009 -3% 0% 3% 6% 9% 12% 15% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 long-run trend % change in CPI from 12 months earlier
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The connection between money and prices • Inflation rate = the percentage increase in the average level of prices. • Price = amount of money required to buy a good. • Because prices are defined in terms of money, we need to consider the nature of money, the supply of money, and how it is controlled.
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Money: Definition Money is the stock of assets that can be readily used to make transactions.
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Money: Functions • medium of exchange we use it to buy stuff • store of value transfers purchasing power from the present to the future • unit of account the common unit by which everyone measures prices and values
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Money: Types 1. Fiat money – has no intrinsic value – example: the paper currency we use 2. Commodity money – has intrinsic value – examples: gold coins, cigarettes in P.O.W. camps
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The money supply and monetary policy definitions • The money supply is the quantity of money available in the economy. Monetary policy is the control over the money supply.
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The central bank • Monetary policy is conducted by a country’s central bank . • In the U.S., the central bank is called the Federal Reserve (“the Fed”). The Federal Reserve Building Washington, DC
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Money supply measures, May 2009 $8328 M1 + small time deposits, savings deposits, money market mutual funds, money market deposit accounts M2 $1596 C + demand deposits, travelers’ checks, other checkable deposits M1 $850 Currency C amount ($ billions) assets included symbol
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The Quantity Theory of Money • A simple theory linking the inflation rate to the growth rate of the money supply. • Begins with the concept of velocity
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Velocity • basic concept: the rate at which money circulates • definition: the number of times the average dollar bill changes hands in a given time period • example: In 2009, – $500 billion in transactions – money supply = $100 billion – The average dollar is used in five transactions in 2009 – So, velocity = 5
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Velocity, cont. • This suggests the following definition: T V M = where V = velocity T = value of all transactions M = money supply
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Velocity, cont. • Use nominal GDP as a proxy for total transactions. Then, PY V M × = where P = price of output (GDP deflator) Y = quantity of output (real GDP) P × Y = value of output (nominal GDP)
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The quantity equation • The quantity equation M × V = P × Y follows from the preceding definition of velocity.
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This note was uploaded on 02/05/2011 for the course BUAD 500 taught by Professor Wilson during the Spring '11 term at William & Mary.

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Chapter 4 student - Money and Inflation An economist is someone who knows the price of everything and the value of nothing Topics and Concepts The

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