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Econ 1BB3 - Chapter 11 Part 1.docx

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Bridget O' Shaughnessy

Richard Damra Tuesday, February 26, 2013 Econ 1BB3 – Chapter 11 Why is the inflation rate 2.5% in Canada but 19% in Venezuela? Classical Theory of Inflation  Price of a good – reflects value  Money – Value falls as the price level rises  Demand for money (households) – as prices rise we need more money to buy the same goods.  The demand for money curve has a negative slope   When P goes up, value of money goes down  Vertical axis = 1/P (Value of money)  If 1/P goes down P goes up and vice versa  Md (Money Demand) – shift out if Y rises or if households decide to increase their money holdings for some other reason.  Y stands for several things, depends on context, in this context, Income. Can also be GDP (Output).  Ms (Money Supply) vertical – position determined by the central bank  Increasing the money supply shifting the line to the right, decreasing shifting to the left.  Richard Damra Tuesday, February 26, 2013 Quantity theory of Money  Quantity theory of money: o The quantity of money determines the price level o The growth rate of money determines the inflation rate o The faster the money is printed the faster the growth of inflation rate (Answer to lecture’s question  Classical dichotomy: the separation of real and nominal variables. Real variable are measured in physical quantities or their relatives’ i.e sack of potatoes in terms of rice or measured in some form of constant dollars. Nominal is measured in terms of current dollars. Real variables are determined by other real variables  Monetary neutrality: Changes in Ms affect nominal variables, but not real variables. Vel
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