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ECON 1000
Nick Rowe

Exam: ECON 1000C Date: Thursday, April 19 at 9:00am Place: Field House, Rows 34-50 Covers: Macro Chapters 5-17 Study: Textbook, Assignments, Past Exams and Study Guide Pass Mock Exam: Tues April 17 6-8pm, Wed April 18: 12-2pm (AP 132) Email: [email protected] Review Chapters 5-17 Part 2 Money Prices and Inflation Continued The Velocity of Money Equation • What is the velocity of money? o The rate at which money changes hands / the number of transactions in which the average dollar is used o The Velocity Formula: V = (P x Y) / M • V = velocity of money • P x Y = nominal GDP = price level x real GDP • M = money supply The Quantity Equation • Is a restatement of the velocity equation • Quantity equation: M x V = P x Y o V is constant/stable o Y is unaffected by money developments (money supply) as it is a real variable o If money supply (M) is doubed, nominal GDP (P x Y) doubles, since real GDP (Y) unaffected by monetary developments, then price (P) doubles Foreign Sector and the Open Economy Exchange Rates • Nominal exchange rate: o The rate at which a person can trade the currency of one country for the currency of another • Real exchange rate: o The rate at which the goods and services of one country trade for the goods and services of another o Real exchange rate: (e x P)/(P*) • E = nominal exchange rate • P = domestic price • P* = the foreign price (in foreign currency) of same good or goods • Basically, e x P is the price of the good in Canada stated in a foreign currency Purchasing Power Parity • Purchasing Power Partity: o Theory explaining the variation of currency exchange rates ( e ) o Theory based on principle called the law of one price: a good must sell for the same price in all locations o PPP implies that nominal exchange rates ( e ) adjust to equalize the price of a basket of goods across countries o Real exchange rate = (e x P)/P* = 1 • E adjusts so price is the same in both markets • If e x P = P*, then real exchange rate = 1 Implications of Purchasing Power Parity (PPP) •What would tend to happen if (e x P)/P* < 1 ? o E is less than predicted by PPP, and therefore e would tend to rise in order to being the exchange rate equal to one. This means that the Canadian dollar was undervalued •What would tend to happen if (e x P)/P* > 1 ? o That means that the price in Canada exceeds the price abroad, and therefore the dollar is overvalued. E is more than predicted by PPP and therefore will fall. Saving and Investment in an O
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