ECON102 Lecture Notes - Demand For Money, Money Supply, Economic Equilibrium

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Published on 16 Oct 2011
School
University of Waterloo
Department
Economics
Course
ECON102
Econ 102 Chapter 11 Notes Prof: Angela Trimarchi
Chapter 11
Inflation
An increase in the overall level of prices, as measured by the
Consumer Price Index or the GDP Deflator
Causes of Inflation in the Long Run
Determined by the growth of the money supply
Level of Prices and the Value of Money
Inflation is more about the value of money than about the value
of goods
Two Alternative Views of the Price Level
When the price level rises, people have to pay more for the
goods and services
A rise in the price level means a lower value of money
Money Supply, Money Demand and
Monetary Equilibrium
The value of money is determined by the supply and demand for
money
A higher price level (a lower value of money)
Increases the quantity of money demanded
In the long-run the overall level of prices adjusts to the level at
which the demand for money equals the supply
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Effects of a Monetary Injection
11-2
Value of
Money, 1/P
Money supply Price
Level,
P
1 (Low)
1.33
2
4
(High)
Quantity of
Money
Quantity fixed
by the Bank of Canada
Money
demand
(Low) 0
(High) 1
3/4
1/2
1/4
Equilibrium
value of
money
Equilibrium
price level
A
How Supply and Demand for Money Determine the Equilibrium Price
Value of
Money, 1/P
Money supply Price
Level,
P
1 (Low)
1.33
2
4
(High)
Quantity of
Money
Quantity fixed
by the Bank of Canada
Money
demand
(Low) 0
(High) 1
3/4
1/2
1/4
Equilibrium
value of
money
Equilibrium
price level
A
B
XW
B
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Quantity Theory of Money
States that the quantity of money available in the economy
determines the:
Value of money
Growth in the quantity of money is the primary cause of inflation
Velocity of Money - (A key concept in the quantity theory of money)
Definition
The rate (speed) at which money circulates or turns over
(changes hands) in the economy
Velocity - Formula
V = (P * Y)
M
V - Velocity
P - Price
Y - Real Output
M - Money Supply
Equation of Exchange
M * V = P * Y
Example with the Equation of Exchange
Bill the baker suddenly discovers that he is short of candles and so
rushes over to the shop of Wick the candle-maker who has just produced 10
candles and is selling them for $1 each. In receipt of this $10 income, Wick
decides to buy a new pair of jeans produced by Tammy the tailor and pays
for them with the $10 bill. Feeling a little hungry after working on the jeans,
Tammy decides to indulge herself by spending the $10 bill on 5 loaves of
bread at $2 a loaf from Bill the baker
Summary of Economic Activity
10 candles @ $1 = $10
1 pair of jeans @ $10 = $10
5 loaves @ $2 = $10
(P * Y) = $30
In other words,
Nominal GDP = P * Y
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Document Summary

An increase in the overall level of prices, as measured by the. Determined by the growth of the money supply. Level of prices and the value of money. Inflation is more about the value of money than about the value of goods. When the price level rises, people have to pay more for the goods and services. A rise in the price level means a lower value of money. The value of money is determined by the supply and demand for money which the demand for money equals the supply. A higher price level (a lower value of money) In the long-run the overall level of prices adjusts to the level at. How supply and demand for money determine the equilibrium price. States that the quantity of money available in the economy. Growth in the quantity of money is the primary cause of inflation. Velocity of money - (a key concept in the quantity theory of money)