Chapter 11 - Money Growth and Inflation.docx

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Chapter 11 - Money Growth and Inflation
The increase in the overall level of prices is called inflation.
The decrease in the overall level of prices is called deflation.
An extraordinarily high rate of inflation is called hyperinflation.
The classical theory of inflation
Often called “classical” because it was developed by some of the earliest thinkers about
economic issues.
The level of prices and the value of money
Inflation is an economy-wide phenomenon that concerns, first and foremost, the value of
the economy’s medium of exchange.
Price level as a measure of the value of money a rise in the price level means a lower
value of money because each dollar in your wallet now buys a smaller quantity of goods
and services.
If P is the price of goods and services measure in terms of money, 1/P is the value of money
measured in terms of goods and services. Thus, when the overall price level rises, the value
of money falls.
Money supply, money demand, and monetary equilibrium
Supply and demand determine the value of money.
The demand for money reflects how much wealth people want to hold in liquid form.
Discussions of the demand for money are sometimes referred to as discussions of “liquidity
preference.”
The average level of prices in the economy is on variable that affects the demand for
money.
A higher price level (a lower value of money) increases the quantity of money demanded.
In the long run, the overall level of prices adjusts to the level at which the demand for
money equals the supply.
When the value of money is high, the price level is low.
When the value of money is low, the price level is high.
The effects of a monetary injection
When an increase in the money supply makes dollars more plentiful, the result is an
increase in the price level that makes each dollar less valuable.
Quantity theory of money: a theory asserting that the quantity of money available
determines the price level and that the growth rate in the quantity of money available
determines the inflation rate.
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