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Chapter 11

ECON 1000 Chapter Notes - Chapter 11: Fallacy, Nominal Interest Rate, Money Creation


Department
Economics
Course Code
ECON 1000
Professor
Troy Joseph
Chapter
11

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Chapter 11 Money Growth and Inflation
Inflation: increase in overall level of prices
The Classical Theory of Inflation
The Level of Prices and the Value of Money
Inflation is more about the money than about the value of goods
Inflation is an economy-wide phenomenon that concerns the value of the economy’s medium of
exchange
Suppose:
oP = price level as measured by the CPI or GDP deflator
oThen P measures number of dollars needed 2 buy basket of G&S
oQuantity of G&S that can be bought with $1 = 1/P
oIf P is the price of G&S measured in terms of money, 1/P is the value of money measured
in terms of G&S
oWHEN OVERALL PRICE LEVEL RISES, VALUE OF MONEY FALLS
Money Supply, Money Demand, and Monetary Equilibrium
Supply and demand determines the value of money
IN THE LONG RUN, THE OVERALL LEVEL OF PRICES ADJUSTS TO THE LEVEL AT
WHICH THE DEMAND FOR MONEY EQUALS THE SUPPLY
oIf price level above equilibrium level, people want to hold more money than the bank has
created so price level must fall 2 balance supply & demand
oIf price level below equilibrium level, people want to hold less money than the bank has
created so the price level must rise 2 balance supply & demand
The Effects of a Monetary Injection
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Chapter 11 Money Growth and Inflation
Economy in equilibrium but bank doubles supply of money by printing bills and dropping them
from helicopters
When increase in money supply makes dollars more plentiful, result is increase in price level that
makes each dollar less valuable
Quantity Theory of Money: quantity of money available determines price level and the growth
rate in the quantity of money available determines inflation rate
A Brief Look at the Adjustment Process
Immediate effect of monetary injection: create an excess supply of money
Get rid of excess supply of money:
oBuy G&S with their excess holdings of money
oMake loans 2 others by buying bonds or depositing the money into a bank savings
account  allowing other people 2 buy G&S
oBOTH increase demand for G&S
Greater demand 4 G&S causes prices of G&S to increase
The increase in the price level, increases the quantity of money demanded b/c people using more
dollars for every transaction
The Classical Dichotomy and Monetary Neutrality
Nominal Variables: variables measured in monetary units, dollar prices
Real Variables: variables measured in physical units, relative prices
Classical Dichotomy: separation of nominal and real variables
Relative Price: price of one thing compared to another ($ signs cancel out)
Different forces influence real and nominal variables
Changes in supply of money affect nominal variables but NOT real variables
Monetary Neutrality: changes in money supply do not affect real variables
oGovernment changed 100 cm to 50 cm, nominal (measured) would double, but real
(actual) would remain the same.
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