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Chapter 17 PP Slides - The Value of Money P = the price...

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4/30/2010 1 Money and Inflation Material corresponding to Mankiw, Chapter 17 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. 1 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. The Quantity Theory of Money Developed by 18 th century philosopher David Hume and the classical economists Advocated more recently by Nobel Prize Laureate Milton Friedman Asserts that the quantity of money determines the 2 Asserts that the quantity of money determines the value of money 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. 3
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