chapter 7 Flashcards
What does the equation of exchange do?
shows the relationship between prices and the money supply
What is the equation of exchange?
MV=PQ (M=money supply. P=price level. Q=amount of output produced by the economy-fixed.)
What does the V stand for in the equation of exchange?
V=velocity. The average number of times a dollar changes hands in a year. Fixed over a short period of time.
Common sense interpretation of the equation of exchange?
a year’s worth of output in the economy is bought by the money supple which is spent and respent V times per year.
Where does inflation come from?
When the Fed and banks increase the money supply
How can all consumers spend more on all goods and services without their nominal savings?
money supply must have increased
Which assumptions does the simple quantity theory rest on?
The equation of exchange applies. Velocity is constant. Output is constant.
What is the prediction of the simple quantity theory?
money supply and price level are proportionally related
What assumptions does monetarism make about the equation of exchange?
Velocity is a stable function of a few variables. Output may change in the short run, but in the long run, output is at the economy’s potential, with labor markets at equilibrium. Equation of exchange holds.
What happens in the short run and the long run with Friedman’s helicopter drop?
short run: prices/output increase.
longrun: wages increase, output at economy’s potential, but with increasing prices.
Under what conditions would inflation have zero effect on the economy?
If it is wholly anticipated and evenly spread throughout the economy.
If all prices in the economy double, how does the qatnity of goods/services produced change?
it doesn’t change.
What is a way to avoid being made worse off by anticipated inflation?
Buy goods/services whose prices inflate before inflation starts.
Who gains and loses with anticipated inflation?
borrowers gain and lenders lose
real interest rate
nominal rate - expected inflation rate