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Unformatted text preview: Click to edit Master subtitle style Money and Inflation An economist is someone who knows the price of everything and the value of nothing. Topics and Concepts The classical theory of inflation causes effects social costs Classical assumes prices are flexible & markets clear Applies to the long run Inflation and its trend, 1960-2009-3 % % 3 % 6 % 9 % 12 % 15 % 196 196 197 197 198 198 199 199 200 200 201 long-run trend % change in CPI from 12 months earlier 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. Money: Definition Money is the stock of assets that can be readily used to make transactions. 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 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 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. The central bank Monetary policy is conducted by a countrys central bank . In the U.S., the central bank is called the Federal Reserve (the Fed). The Federal Reserve Building Washington, DC 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 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 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 Velocity, cont. This suggests the following definition: T V M = where V = velocity T = value of all transactions M = money supply Velocity, cont. Use nominal GDP as a proxy for total transactions. Then, P Y V M = where P = price of output (GDP deflator) Y = quantity of output (real GDP) P VY = value of output (nominal GDP) The quantity equation The quantity equation M VV = P VY 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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