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Lec09handout - Money Growth and Inflation Slide #09 July 20...

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Money Growth and Inflation Slide #09 July 20 2010
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Inflation Inflation Increase in the overall level of prices Deflation Decrease in the overall level of prices Hyperinflation Extraordinarily high rate of inflation 2
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The Classical Theory of Inflation The level of prices and the value of money Inflation Economy-wide phenomenon Concerns the value of economy’s medium of exchange Inflation - rise in the price level Lower value of money Each dollar - buys a smaller quantity of goods and services 3
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The Classical Theory of Inflation Money demand Reflects how much wealth people want to hold in liquid form Depends on Credit cards; ATM machines; Interest rate Average level of prices in economy Demand curve downward sloping 4
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The Classical Theory of Inflation Money supply Determined by the Fed and banking system Supply curve - vertical Monetary equilibrium In the long run Overall level of prices adjusts to: Demand for money equals the supply 5
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How the supply and demand for money determine the equilibrium price level 1 6 Quantity of Money 0 (high) (low) Value of Money, 1/ P 1 ¾ ½ ¼ Price Level, P 1 1.33 2 4 (high) (low) Money Demand Quantity fixed by the Fed Money Supply A Equilibrium value of money Equilibrium price level The horizontal axis shows the quantity of money. The left vertical axis shows the value of money, and the right vertical axis shows the price level. The supply curve for money is vertical because the quantity of money supplied is fixed by the Fed. The demand curve for money is downward sloping because people want to hold a larger quantity of money when each dollar buys less. At the equilibrium, point A, the value of money (on the left axis) and the price level (on the right axis) have adjusted to bring the quantity of money supplied and the quantity of money demanded into balance.
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The Classical Theory of Inflation The effects of a monetary injection Economy in equilibrium The Fed doubles the supply of money Prints bills; Drops them on market Or: The Fed open-market purchase New equilibrium Supply curve shifts right Value of money decreases Price level increases 7
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An increase in the money supply 2 8 Quantity of Money 0 (high) (low) Value of Money, 1/ P 1 ¾ ½ ¼ Price Level, P 1 1.33 2 4 (high) (low) Money Demand M 1 MS 1 A When the Fed increases the supply of money, the money supply curve shifts from MS 1 to MS 2 . The value of money (on the left axis) and the price level (on the right axis) adjust to bring supply
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This document was uploaded on 10/28/2011 for the course 220 103 at Rutgers.

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Lec09handout - Money Growth and Inflation Slide #09 July 20...

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