Money Growth And Inflation

Front 1

inflation

Back 1

sustained and continuous increase in prices

(average about 4% each year)
(drives up the prices and drives down the value of the dollar)
-ultimately, the value of the dollar goes down

Front 2

deflation

Back 2

the opposite of inflation
--> sustained and continuous decrease in prices

Front 3

level of prices

Back 3

-when the price level rises
-people have to pay more for them
*a rise in prices also means that the value of the dollar is lower, (each dollar buys a smaller amount of goods)*

Front 4

Price level formula

Back 4

( 1/P )

P=price level (p= CPI or GDP deflator)

Front 5

the value of $1

Back 5

( 1/P ) value of $1 measured in goods

Front 6

the quantity theory of money

Back 6

-the quantity of money determines the value of it

(studied by a supply and demand graph and a equation)

Front 7

the money supply

Back 7

-in the real world: the fed, consumers, and banks control the MS
-in this model it is fixed until the fed changes it (thus making it vertical)

Front 8

money demand

Back 8

-how much liquid money people want to hold

Front 9

the money supply demand diagram

Back 9

----

Front 10

money

Back 10

-the higher the price, the more that is demanded because more money is needed to purchase the same amount of goods
-more money is needed to purchase the goods and services

Front 11

money demand?
money rises price level lowers price level=price of the product price level rises you need more money to buy stuff
-slide 4-

Back 11

-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 and interest rates)
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Front 12

the money supply diagram

Back 12

-as the price of money rises, the price level falls
-because the price level falls, more is demanded
-price adjusts to equate the demand and supply
*if the Fed increases the money supply, value falls and price rises*

Front 13

The adjustment process of the money supply diagram

Back 13

-increasing the money supply causes the price to rise

-increase in money supply causes excess supply
-people get rid of extra $ = more demand for goods
-however, supply of goods DOESNT increase, so price rises

Front 14

Nominal variables

Back 14

-measured in monetary units
(money per hour that is worked, nominal interest rate--> rate of return measured in $)

Front 15

Real variables

Back 15

-measured in physical units
(real interest rate --> measured in output or real wage --> measured in output)

Front 16

relative price

Back 16

the price of one good divided by another
(1 good / another good)
(Price of CD/ price of Pizza) 1.5 pizzas per CD
*measured in physical units = real variable*

Front 17

classica dichotomy

Back 17

the theoretical separation of real and nominal variables
-->some economists say that monetary developments effect nominal variables ONLY and not real
(ex. if money supplied is double, then nominal variables will double however, real variables will NOT)

Front 18

monetary neutrality

Back 18

the theory that changes in the money supply do NOT effect real variables
-when money supplied is doubled, the relative price remains unchanged
(ex. $15 CD/ $10 pizza = $1.5 pizzas per CD
Doubled:
$30 CD/ $20 pizza = $1.5 pizzas per CD)
*relative price remains unchanged*

Front 19

velocity of money

Back 19

the number of transactions in which the average dollar is used
-fairly stable in the long run-

Front 20

velocity formula

Back 20

(Price X Output) = nominal GDP= (price level X realGDP)
V=
Money Supply
-

Front 21

the quantity explanation
*used when technology and resources are being changed*

Back 21

M X V = (P X Y)
*multiplied by the money supply*
-a change in the money supply causes change in the nominal GDP
**a change in the money supply does NOT effect Y because Y is ONLY effected by technology and resources**
-->change in M (money supply) causes proportional changes in P (Price)
(rapid money supply growth causes rapid inflation)

Front 22

Number of transactions

Back 22

= economic growth

Front 23

the quantity theory of money

Back 23

-if GDP is constant, then inflation rate= money growth rate
-if GDP is growing then, inflation rate < money growth rate

-->economic growth increases number of transactions
-->excessive money growth causes inflation

Front 24

hyperinflation

Back 24

inflation exceeding 50% each month
(Zimbabwe)

Front 25

inflation tax

Back 25

when
-tax revenue is inadequate
-gov.'s ability to borrow is limited
= the gov. may print more money to pay for their deficit
--> this causes inflation tax (tax on anyone who holds money)
*almost ALL hyper inflations are started this way, your dollars become less valuable*

Front 26

the Fisher effect
(formula)

Back 26

nominal GDP = inflation rate + real interest rate
- in the long run money is neutral (money supply changes only effect nominal variables, actual money)
-change in the money supply effects the inflation rate but not the real interest rate
-Nominal interest rate adjusts 1-for-1 in inflation rate

Front 27

the Fisher effect
-->real interest rate

Back 27

-the real interest rate is only effected if there is a change in:
-->savings
-->investment in loanable funds

Front 28

inflation fallacy

Back 28

-people think that inflation decreases their income FALSE
-inflation is an increase on prices that you buy AND sell
-->incomes are determined by real variables NOT the inflation rate

Front 29

inflation, earnings, and CPI

Back 29

inflation causes hourly wages and CPI to rise together over the long run

Front 30

costs of inflation

Back 30

-shoeleather costs
-menu costs
-misallocation of resources

Front 31

shoeleather costs

Back 31

-during inflation, when resources are wasted
(people take their money out of the bank)

Front 32

menu costs

Back 32

-cost of changing new prices
(printing new menus for the new prices and mailing out new catalogues)

Front 33

misallocation of resources

Back 33

-firms dont all raise prices at the same time so relative prices can vary which distorts the allocation of resources

Front 34

costs of inflation:
-tax distortions

Back 34

-inflation makes nominal income grow faster than real income
-taxes are based on nominal income and some are not adjusted for inflation
-inflation causes people to pay more taxes even though their real income doesn't increase