Chapter 17 PP Slides

Chapter 17 PP Slides - 4/30/2010 The Value of Money P = the...

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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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4/30/2010 2 The Money Supply-Demand Diagram Value of Money, 1/ P Price Level, P 11 ¾ 1.33 As the value of money rises, the price level falls. 4 Quantity of Money ½2 ¼ 4 The Money Supply-Demand Diagram Value of Money, 1/ P Price Level, P 1 ¾ 1 1.33 MS 1 5 Quantity of Money ½ ¼ 2 4 $1000 The Fed sets MS at some fixed value, regardless of P . The Money Supply-Demand Diagram Value of Money, 1/ P Price Level, P 1 ¾ 1 1.33 A fall in value of money (or increase in P ) increases the quantity of money demanded: 6 Quantity of Money ½ ¼ 2 4 MD 1 MS 1 Value of Money, 1/ P Price Level, P 1 ¾ 1 1.33 The Money Supply-Demand Diagram P adjusts to equate quantity of money demanded with money supply. 7 $1000 Quantity of Money ½ ¼ 2 4 MD 1 eq’m price level eq’m value of money A
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4/30/2010 3 MS 1 The Effects of a Monetary Injection Value of Money, 1/ P Price Level, P MS 2 Then the value of money falls, and P rises. Suppose the Fed increases the money supply. 8 $1000 Quantity of Money ½ ¼ 2 4 MD 1 eq’m price level eq’m value of money A $2000 B Real vs. Nominal Variables Nominal variables are measured in monetary units.
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This note was uploaded on 08/24/2011 for the course ECO 304L taught by Professor Bencivenga during the Spring '10 term at University of Texas.

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Chapter 17 PP Slides - 4/30/2010 The Value of Money P = the...

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