Chapter 17 PowerPoint

Chapter 17 PowerPoint - 17 rates Money Growth and Inflation...

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1 CHAPTER 17 MONEY GROWTH AND INFLATION How money supply affects inflation and nominal interest rates Does the money supply affect real variables like real GDP or the real interest rate? How is inflation like a tax? What are the costs of inflation? How serious are they? 17 Preview Preview Money Growth and Inflation Money Growth and Inflation
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2 CHAPTER 17 MONEY GROWTH AND INFLATION Introduction This chapter introduces the quantity theory of money to explain one of the Ten Principles of Economics from Chapter 1: Prices rise when the govt prints too much money. Most economists believe the quantity theory is a good explanation of the long run behavior of inflation.
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3 CHAPTER 17 MONEY GROWTH AND INFLATION 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. 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.
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4 CHAPTER 17 MONEY GROWTH AND INFLATION 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. States that the quantity of money determines the value of money. We study this theory using two approaches: 1. a supply-demand diagram 2. an equation
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5 CHAPTER 17 MONEY GROWTH AND INFLATION 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.
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6 CHAPTER 17 MONEY GROWTH AND INFLATION Money Demand (MD) Refers to how much wealth people want to hold in liquid form. Depends on P : An increase in P reduces the value of money, Thus, quantity of money demanded is negatively related to the value of money and positively related to P , other things equal. (These “other things” include real income, interest rates, availability of ATMs.)
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7 CHAPTER 17 MONEY GROWTH AND INFLATION The Money Supply-Money Demand Diagram Value of Money, 1/ P Price Level, P Quantity of Money 1 1 ¾ 1.33 ½ 2 ¼ 4 As the value of money rises, the price level falls.
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8 CHAPTER 17 MONEY GROWTH AND INFLATION The Money Supply-Demand Diagram Value of Money, 1/ P Price Level, P Quantity of Money 1 ¾ ½ ¼ 1 1.33 2 4 MS 1 $1000 The Fed sets MS at some fixed value, regardless of P .
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9 CHAPTER 17 MONEY GROWTH AND INFLATION The Money Supply-Demand Diagram Value of Money, 1/ P Price Level, P Quantity of Money 1 ¾ ½ ¼ 1 1.33 2 4 MD 1 A fall in value of money (or increase in P ) increases the quantity of money demanded:
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CHAPTER 17 MONEY GROWTH AND INFLATION MS 1 $1000 Value of Money, 1/ P Price Level, P Quantity of Money 1 ¾ ½ ¼ 1 1.33 2 4 The Money Supply-Demand Diagram
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This note was uploaded on 04/07/2008 for the course BSAD ECON 040 011 taught by Professor Boveemora during the Spring '08 term at Vermont.

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Chapter 17 PowerPoint - 17 rates Money Growth and Inflation...

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