Class Notes (905,023)
CA (538,335)
UTSC (32,636)
MGEB06H3 (76)
Lecture 5

Week 5 chapter notes

3 Pages
154 Views

Department
Economics for Management Studies
Course Code
MGEB06H3
Professor
Jack Parkinson

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Chapter 4 Money and Inflation Notes
x inflation Æ an increase in the overall level of prices
x hyperinflation Æ extremely high inflation
4.1 What is Money?
x money Æ the stock of assets used for transactions
The Functions of Money
x money has three purposes: store of value, unit of account, and a medium of exchange
x store of value Æ a way of transferring purchasing power from the present to the future; one of the functions of money
x unit of account Æ the measure in which prices and other accounting records are recorded; one of the functions of money
x medium of exchange Æ the item widely accepted in transactions for goods and services; one of the functions of money
The Types of Money
x fiat money Æ money that is not intrinsically useful and is valued only because it is used as money
x commodity money Æ money that is intrinsically useful and would be valued even if it did not serve as money
x gold standard Æ a monetary system in which gold serves as money or in which all money is convertible into gold
How the Quantity of Money is Controlled
x the quantity of money supplied in an economy is called the money supply
x in a system of commodity money, the money supply is the quantity of that commodity
x in an economy that uses fiat money, the government controls the supply of money as they print the money
x monetary policy Æ the central bank’s choice regarding the supply of money
x central bank Æ the institution responsible for the conduct of monetary policy, such as the Bank of Canada in Canada
x Bank of Canada Æ the central bank of Canada
x open-market operations Æ purchase or sale of government bonds by CB for purpose of increasing or decreasing money supply
How the Quantity of Money is Measured
x because money is the stock of assets used for transactions, the quantity of money is the quantity of those assets
x currency Æ the sum of outstanding paper money and coins
x demand deposit Æ assets that are held in banks and can be used on demand to make transactions, such as chequing accounts
x demand deposits are added to currency when measuring the quantity of money
Symbol Assets Included
B Currency plus chartered bank deposits at the Bank of Canada
M1 Sum of currency in circulation, demand deposits, and other chequing deposits at chartered banks
M2 Sum of M1 plus personal savings deposits and non-personal notice deposits at chartered banks
M2+ Sum of M2 plus all deposits and shares at trust companies, mortgage loan companies, credit unions, and Caisses Populaires
M3 Sum of M2 plus fixed-term deposits of firms at chartered banks
4.2 The Quantity Theory of Money
Transactions and the Quantity Equation
x quantity equation Æ identity stating that product of money supply and velocity of the money equals nominal expenditure (MV =
PY); coupled with the assumption of stable velocity, an explanation of nominal expenditure called the quantity theory of money
x Money (M) × Velocity (V) = Price (P) × Transaction (T)
x T represents the total number of transactions during some period of time; P is the price of a typical transaction
x the product of the price of a transaction and the number of transactions, PT, equals the number of dollars exchanged in a period
x M is quantity of money; V is called transaction velocity of money and measures rate at which money circulates in economy
x the quantity equation is an identity: the definition of the 4 variables make it true
x this equation is useful because if shows that if one of variables changes, one or more of others must change to maintain equality
From Transactions to Income
x the problem with the equation is that the number of transactions is difficult to measure
x to solve this problem, the number of transactions T is replaced by the total output of the economy Y
x if Y denotes the amount of output and P denotes the price of one unit of output, then the dollar value of output is PY
x because Y is also total income, V in this version of the quantity equation is called the income velocity of money
The Money Demand Function and the Quantity Equation
x real money balances Æ the quantity of money expressed in terms of the quantity of goods and services it can buy (M / P)
x money demand function Æ a function showing the determinants of the demand for real money balances
x simple demand function is (M / P)d = kY, where k is a constant on how much money people hold for every dollar of income
x this equation states that the quantity of real money balances demanded is proportional to real income
x when people want to hold a lot of money for each dollar of income (k is large), money changes hands infrequently (V is small)
x when people want to hold only a little money (k is small), money changes hands frequently (V is large)
The Assumption of Constant Velocity
x quantity theory of money Æ doctrine emphasizing that changes in the quantity of money lead to changes in nominal expenditure
x holding V constant, a change in the quantity of money (M) must cause a proportionate change in nominal GDP (PY)
x that is, if velocity is fixed, the quantity of money determines the dollar value of the economy’s output
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Description
Chapter 4 Money and Inflation Notes N inflation an increase in the overall level of prices N hyperinflation extremely high inflation 4.1 What is Money? N money the stock of assets used for transactions The Functions of Money N money has three purposes: store of value, unit of account, and a medium of exchange N store of value a way of transferring purchasing power from the present to the future; one of the functions of money N unit of account the measure in which prices and other accounting records are recorded; one of the functions of money N medium of exchange the item widely accepted in transactions for goods and services; one of the functions of money The Types of Money N fiat money money that is not intrinsically useful and is valued only because it is used as money N commodity money money that is intrinsically useful and would be valued even if it did not serve as money N gold standard a monetary system in which gold serves as money or in which all money is convertible into gold How the Quantity of Money is Controlled N the quantity of money supplied in an economy is called the money supply N in a system of commodity money, the money supply is the quantity of that commodity N in an economy that uses fiat money, the government controls the supply of money as they print the money N monetary policy the central banks choice regarding the supply of money N central bank the institution responsible for the conduct of monetary policy, such as the Bank of Canada in Canada N Bank of Canada the central bank of Canada N open-market operations purchase or sale of government bonds by CB for purpose of increasing or decreasing money supply How the Quantity of Money is Measured N because money is the stock of assets used for transactions, the quantity of money is the quantity of those assets N currency the sum of outstanding paper money and coins N demand deposit assets that are held in banks and can be used on demand to make transactions, such as chequing accounts N demand deposits are added to currency when measuring the quantity of money Symbol Assets Included B Currency plus chartered bank deposits at the Bank of Canada M1 Sum of currency in circulation, demand deposits, and other chequing deposits at chartered banks M2 Sum of M1 plus personal savings deposits and non-personal notice deposits at chartered banks M2+ Sum of M2 plus all deposits and shares at trust companies, mortgage loan companies, credit unions, and Caisses Populaires M3 Sum of M2 plus fixed-term deposits of firms at chartered banks 4.2
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