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lecture 19 ~ chapter 11.docx

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Hannah Holmes

Why is the inflation rate 2.5% in Canada but 19% in Venezuela? Classical theory of inflation  Price of a good – reflects value  Price of a good – is determine by the supply and demand  Money – value falls as the price level rises (more money in economy, dollar value decreases)  Demand for money (money demand) – as prices rise we need more money to buy the same goods (households)  has a negative slope  when 1/p goes down, p goes up  M – shift out if Y rises or if households decide to increase their money holdings for some other reason  if income goes up, want to buy more stuff, need more money  if nervous about stock market, money demand shifts out, increases  M^s vertical – position determined by the central bank (can position wherever they want  Quantity theory of money  The quantity of money in the economy determines the price level  The growth rate of money determines the inflation rate  Classical dichotomy: the separation of real and nominal variables  real variables are determined by different tings than nominal variables  model we use to determine interest rates in the economy in the long run = market for loanable funds  Monetary neutrality: changes in M affect nominal variables, but not real variables  households: how much do I want to consume, how much do I want to save; their wealth is an accumulation of past savings Velocity  The rate at which money changes hands Ex. Produce 2000 cps of hot chocolate/week (flow/real variable) $2 per cup (nominal variable) $500 of currency in the economy How many times must each dollar circulate through the economy
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