Chapter 12 Flashcards
what determines the price level in the long run
Money supply, velocity of money, RGDP
real variables
- measure in physical units or base year dollars
- relative to some other points in time other than the present
- more useful for comparisons
- transforms nominal value by taking price level changes into account
- ex, real wages, real interest rates, real GDP
nominal variables
- variables measured in monetary units or current dollars
- price you see when purchasing something, the value you received when paid
- Nominal wages, nominal interest rates, money supply
what is monetary neutrality in reference to real variables
any change in money supply will only affect other nominal variables but not real variables since it does not change resources or technology
quantity theory of money
MV = PY
what is velocity
speed at which money circulates in an economy and influences the relationship between the money supply and prices. A stable velocity contributes to a more predictable relationship, while fluctuations in velocity can complicate the understanding of the money-prices relationship, especially in the short run.
what is 1/P =
value of dollar measured in good
M affects primarily
P and Y when V is stable
if Y is constant
inflation rate = money supply growth rate
what is the inflation fallacy a fallacy
inflation doesn’t normal reduce purchasing power of peoples income or wealth but many people think inflation erodes their ability to buy goods and services
what is the inflation fallacy
normally when there is inflation nominal wages increase as much as prices and real wages, so that you purchasing power remains constant. inflation is a general increase in ALL prices
real wage =
nominal wage - (nominal wage * inflation rate)
why can inflation be seen as a tax
inflation increases money supply = increases prices. when people see increasing prices they think they have lost purchasing power but as long as inflation is expected they have not. people who hold money see it as a tax rather than wealth
what causes hyperinflation
tax revenue is low and govt can’t borrow money so they print money to pay for its spending when government does this excessively this causes hyper inflation
what is the relationship between inflation and interest rate (fisher effect)
increase in inflation = increase in nominal interest rate, but real interest rate on wealth is unchanged. in long run changes in money affect inflation and nominal rates but not real rates, due to sticky wages
as long as inflation is expected nominal wages and rates
will adjust with inflation
inflation doesn’t reduce purchasing power as long as
its expected and there are interest bearing assets
What are the costs of expected inflation
shoe leather, menu costs, misallocation of resources from increasing variability
shoe leather costs
- resources wasted when inflation encourages people to reduce their money holdings
- time and transaction costs of more trips to bank and cost of transferring money to interest bearing assets
menu costs
cost of changing prices. it costs money and time to relabel prices of g and s for a biz
misallocation of resources from increasing variability
resources are not being used in the most effective/efficient way. changes are becoming more unpredictable. Prices of resources could be changing faster than outputs
