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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 . 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

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  1. Ch 28 Money Growth and Inflation I. Historic Look (p628)…inflation vs deflation • hyperinflation

  2. 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

  3. 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.

  4. Price Level Value = 1/P If P< Pe? 1 1/2 2 If P > Pe? 4

  5. 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

  6. Q Theory of Money : • Q of M available determines • the PL • Growth rate of Q of M determines • Inflation Rate

  7. Classical Dichotomy and Monetary Neutrality • How do monetary changes affect other variables (production, employment, wages) • David Hume • classical dichotomy separates “real” and “nominal” variables

  8. 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

  9. 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

  10. Long run vs. Short run • Monetary changes do effect short run • But in long run – only negligible affects on real variables

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