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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
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
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
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
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
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
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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