4/30/20101Money and InflationMaterial corresponding to Mankiw, Chapter 17The Value of MoneyP= the price level (e.g., the CPI or GDP deflator)Pis the price of a basket of goods, measured in money. 1/Pis the value of $1, measured in goods.1Example: basket contains one candy bar.If P= $2, value of $1 is 1/2 candy barIf P= $3, value of $1 is 1/3 candy barInflation drives up prices and drives down the value of money. The Quantity Theory of MoneyDeveloped by 18thcentury philosopher David Hume and the classical economistsAdvocated more recently by Nobel Prize Laureate Milton Friedman Asserts that the quantity of money determines the2Asserts 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
This preview has intentionally blurred sections.
Sign up to view the full version.