Chapter 22 Flashcards
(27 cards)
When the overall price level rises,
the value of money falls
What determines the value of money?
supply and demand
A higher price level (a lower value of money)
increases the quantity of money demanded
The horizontal axis
the quantity of money supplied
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
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 . According to this theory, the quantity of money available in an economy determines the value of money, and growth in the quantity of money is the primary cause of inflation.
Nominal variables
variables measures in monetary units
Real variables
variables measured in physical units
Classical dichotomy
the separation of real and nominal variables
Relative price
the price of one thing in terms of another (the price of a bushel of corn is 2 bushels of wheat)
The real wage( the dollar wage adjusted for inflation)
is a real variable because it measures the rate at which people exchange goods and services for a unit of labor
The real interest rate (the nominal interest rate adjusted for inflation)
is a real variable because it measures the rate at which people exchange goods and services today for goods and services in the future
Monetary neutrality
the irrelevance of monetary changes to real variables
Velocity of money
the rate at which money changes hands
Velocity of money formula
we divide the nominal value of output (nominal GDP) by the quantity of money. If P is the price level (the GDP deflator), Y is the quantity of output (real GDP), and M is the quantity of money.
V=(PxY)/M
MxV=PxY
Quantity equation
the equation MxV=PxY, which relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services
Equilibrium price level and inflation rate explained
- the velocity of money is relatively stable over time
- because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (PxY)
- The economy’s output of goods and services (Y) is determined by factor supplies (labor, physical, capital, human capital, and natural resources) and the available production technology. Since money is neutral,
Equilibrium price level and inflation rate explained
- the velocity of money is relatively stable over time
- because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (PxY)
- The economy’s output of goods and services (Y) is determined by factor supplies (labor, physical, capital, human capital, and natural resources) and the available production technology. Since money is neutral, money does not affect output
- Because output (Y) is fixed by factor supplies and technology, when the central bank alters the money supply (M) and induces a proportional change in the nominal value of output (PxY), this change is reflected in a change in the price level (P)
- Therefore, when the central bank increases the money supply rapidly, the result is a high rate inflation
Equilibrium price level and inflation rate explained. These five points are the essence of the quantity theory of money.
- the velocity of money is relatively stable over time
- because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (PxY)
- The economy’s output of goods and services (Y) is determined by factor supplies (labor, physical, capital, human capital, and natural resources) and the available production technology. Since money is neutral, money does not affect output
- Because output (Y) is fixed by factor supplies and technology, when the central bank alters the money supply (M) and induces a proportional change in the nominal value of output (PxY), this change is reflected in a change in the price level (P)
- Therefore, when the central bank increases the money supply rapidly, the result is a high rate inflation
Inflation tax
the revenue the government raises by creating money . It is not like the other taxes because no one receives a bill from the government for this tax. More subtle. Gov prints money, price level rises, dollars in your wallet become less valuable. Thus, the inflation tax is like a tax on everyone who holds money.
The fischer effect
The one-for-one adjustment of the nominal interest rate to the inflation rate. When the Fed increases the rate of money growth, the long-run result is both a higher inflation and a higher nominal interest rate.
The Fischer effect
The one-for-one adjustment of the nominal interest rate to the inflation rate. When the Fed increases the rate of money growth, the long-run result is both a higher inflation and a higher nominal interest rate.
Shoeleather cost
the resources wasted when inflation encourages people to reduce their money holdings
Menu costs
the cost of changing prices