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Maggie Final Exam Concept Review

Maggie Final Exam Concept Review - TheFunctionsofMoney...

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Econ 002 Review Session
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Material since Midterm II
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The Functions of Money Medium of exchange Store of value Unit of Account Liquidity Services Two Types of Money Commodity Money – backed by commodity Fiat Money 
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Components of the Money Supply M1: currency, demand deposits, traveler’s  checks, other checkable deposits M2: M1+savings deposits+small time  deposits+money market mutual funds
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Equations for Money Supply Calculations Monetary Base = Currency + Reserves Money Supply = Currency + Demand  Deposits Currency –Deposit ratio (cr)= C/D Reserve-Requirement (rr)= R/D Money-multiplier=(cr+1)/(cr+rr) If rr   then M  If cr   then M 
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Fed’s Three Tools of Monetary Control Open market operations Reserve requirements Discount rate   increases money supply   reduces money supply
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M O N E G R W T A F L 7 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.
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Theory of Monetary Changes Quantity Theory of Money: how does the price  level change over time? Quantity of money in the economy  determines the value of money Inflation is mainly caused by growth in the  quantity of money
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The Velocity of Money V = P x Y M The Quantity Equation M x V = P x Y Dollars spent equals number of goods purchased
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M O N E G R W T A F L 10 The Quantity Theory in 5 Steps 1. V   is stable.  2. So, a change in  M  causes nominal GDP ( P  x  Y to change by the same percentage.   3. A change in  M  does not affect  Y :   money is neutral,    Y   is determined by technology & resources 4. So,  P   changes by same percentage as  P  x  Y   and   M . 5. Rapid money supply growth causes rapid  inflation.  Start with quantity equation:    M  x  V   =   P  x  Y
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The Fisher Effect § In the long run, money is neutral,  so a change in the money growth rate affects  the inflation rate but not the real interest rate.   Real interest rate Nominal interest rate Exp. Inflation rate + =
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The Costs of Inflation Shoeleather costs Menu costs Misallocation of resources Confusion and inconvenience Tax distortions Arbitrary redistributions of wealth
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Trade Surpluses and Deficits NX < 0 Deficit NX > 0 Surplus Variables that Influence NX Consumer preferences and incomes Prices of goods Exchange rates Transportation costs Government policies
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