Classical theory of inflation developed by some of the earliest thinkers about economic issues. 2 ways for eco(cid:374)o(cid:373)y"s o(cid:448)erall price le(cid:448)el: as price of a basket of goods & services, as a measure of value of money. Supply of money is controlled by boc & banking system. Value of money is determined by supply & demand for money. Demand for money (cid:862)li(cid:395)uidity p(cid:396)efe(cid:396)e(cid:374)(cid:272)e(cid:863): (cid:396)efle(cid:272)ts ho(cid:449) (cid:373)u(cid:272)h (cid:449)ill ppl (cid:449)a(cid:374)t to hold i(cid:374) li(cid:395)uid fo(cid:396)(cid:373) Many factors affect demand for money: ex. amount of currency that ppl hold in their wallets can depend on how much they rely on credit cards or accessibility of atms. Level of prices in economy = most important variable that explains demand for money. Overall level of prices adjusts to level at which demand for money equals supply. Figure 11. 1: how supply & demand for money -------------> Ex. imagine economy is in equilibrium & suddenly, boc doubles supply of money by printing some dollar bills.