Chapters 22 and 23 (1)

Chapters 22 and 23 (1) - Chapters 22 and 23 Lectures...

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Chapters 22 and 23 Lectures Supratim Das Gupta
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Key Questions to Address: How does the money supply affect inflation and nominal interest rates? Does the money supply affect real variables like real GDP or the real interest rate? What are economic fluctuations? What are their characteristics? How does the model of Aggregate Demand and Aggregate Supply explain economic fluctuations?
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MONEY GROWTH AND INFLATION 3 Chapter 22: Introduction One of the Ten Principles from Chapter 1: Prices rise when the govt prints too much money. This can be explained by the Quantity Theory of Money Most economists believe the quantity theory is a good explanation of the long run behavior of inflation. 0
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MONEY GROWTH AND INFLATION 4 The Value of Money P = the price level ( e.g. , the CPI or GDP deflator) P is the price of a basket of goods, measured in money. 1/ P is the value of $1, measured in goods. Example: basket contains one candy bar. If P = $2, value of $1 is 1/2 candy bar If P = $3, value of $1 is 1/3 candy bar Inflation drives up prices and drives down the value of money. 0
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The Quantity Theory of Money Developed by 18 th century philosopher David Hume and other classical economists A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate Quantity Equation: M x V= P x Y
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MONEY GROWTH AND INFLATION 6 Money Supply (MS) In real world, determined by Federal Reserve, the banking system, consumers. In this model, we assume the Fed precisely controls MS and sets it at some fixed amount. 0
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MONEY GROWTH AND INFLATION 7 Money Demand (MD) Refers to how much wealth people want to hold in liquid form. Depends on P : An increase in P reduces the value of money, so more money is required to buy goods and services. Quantity of money demanded depends positively on P and negatively to the value of money, other things being equal . (These “other things” include real income, interest rates, availability of ATMs.) 0
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MONEY GROWTH AND INFLATION 8 MS 1 $1000 Value of Money, 1/ P Price Level, P Quantity of Money 1 ¾ ½ ¼ 1 1.33 2 4 The Money Supply-Demand Diagram MD 1 P adjusts to equate quantity of money demanded with money supply. eq’m price level eq’m value of money A 0
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MONEY GROWTH AND INFLATION 9 MS 1 $1000 The Effects of a Monetary Injection Value of Money, 1/ P Price Level, P Quantity of Money 1 ¾ ½ ¼ 1 1.33 2 4 MD 1 eq’m price level eq’m value of money A MS 2 $2000 B Then the value of money falls, and P rises. Suppose the Fed increases the money supply. 0
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MONEY GROWTH AND INFLATION 10 A Brief Look at the Adjustment Process How does this work? Short version: At the initial P , an increase in MS causes excess supply of money. People get rid of their excess money by
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This note was uploaded on 06/03/2011 for the course ECON 224 taught by Professor Ozturk during the Fall '09 term at South Carolina.

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Chapters 22 and 23 (1) - Chapters 22 and 23 Lectures...

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