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Ch 28 Money Growth and Inflation . I. Historic Look (p628)…inflation vs deflation hyperinflation. II. Classical Theory of Inflation . P measured by CPI or GDP delator P measures number of dollars needed to buy basket of goods The Q of goods you can buy with one dollar = 1/P

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ch 28 money growth and inflation
Ch 28 Money Growth and Inflation

I. Historic Look (p628)…inflation vs deflation

  • hyperinflation
ii classical theory of inflation
II. Classical Theory of Inflation
  • P measured by CPI or GDP delator
  • P measures number of dollars needed to buy basket of goods
  • The Q of goods you can buy with one dollar = 1/P
  • So….1/P is the value of money measured in terms of goods and services it buys
  • So….as P rises,,,,,the value of money falls
iii value of money supply and demand
III. Value of Money (Supply and Demand)
  • Money Supply (Fed and banking system); MS is vertical because _____________
  • Money Demand :MD is downward sloping because __many___determinants: use of credit cards, interest rates, etc.
  • --most impt. = price level
  • the higher P = lower value of money = more money demanded to buy goods.
  • --the higher P = people hold more money.
slide4

Price Level

Value = 1/P

If P< Pe?

1

1/2

2

If P > Pe?

4

slide5

Monetary Injection…immediate impact? :

Surplus = …..

Spend or save (= more spending) = …increase AD…..but…?

Ability to produce has not changed….so…..

Price Level

Value = 1/P

1

Creates rise in PL and increase in QD b/c now need more for every transaction

1/2

2

4

slide6

Q Theory of Money :

  • Q of M available determines
  • the PL
  • Growth rate of Q of M determines
  • Inflation Rate
classical dichotomy and monetary neutrality
Classical Dichotomy and Monetary Neutrality
  • How do monetary changes affect other variables (production, employment, wages)
  • David Hume
  • classical dichotomy separates “real” and “nominal” variables
applications
Applications
  • Price of corn = $2/bushel …. = nominal
  • But the “relative” price: bushel of corn = two bushels of wheat ….. = real
  • Dollar prices are nominal ; relative prices are real
  • Ex: real wage = real variable
analogy
Analogy
  • If MS doubles, all P double and the value of a dollar falls by ½
  • If change yard from 36 to 18 inches: all measured distances (nominal) would double, but the actual distances (real) would not change
long run vs short run
Long run vs. Short run
  • Monetary changes do effect short run
  • But in long run – only negligible affects on real variables