Chs. 17, 20-22 Flashcards
Does a higher price level increase the quantity of money demanded?
Yes. People can use money to buy the goods and services on their shopping lists. How much money they choose to hold for this purpose depends on the prices of those goods and services. The higher prices are, the more money the typical transaction requires, and the more money people will choose to hold in their wallets and checking accounts. That is, a higher price level (a lower value of money) increases the quantity of money demanded.
What ensures that the quantity of money the Fed supplies balances the quantity of money people demand in the long run?
In the long run, money supply and money demand are brought into equilibrium by the overall level of prices. If the price level is above the equilibrium level, people will want to hold more money than the Fed has created, so the price level must fall to balance supply and demand. If the price level is below the equilibrium level, people will want to hold less money than the Fed has created, and the price level must rise to balance supply and demand. At the equilibrium price level, the quantity of money that people want to hold exactly balances the quantity of money supplied by the Fed.
What happens to the price level and the value of a dollar when there is an increase in money supply?
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.
What is the quantity theory of money?
According to the quantity 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.
What is the adjustment process after an injection of money into the economy?
The immediate effect of a monetary injection is to create an excess supply of money. Before the injection, the economy was in equilibrium. At the prevailing price level, the quantity of money supplied now exceeds the quantity demanded. People try to get rid of the excess supply of money, so the demand for goods and services increases. But the economy’s ability to supply goods and services has not changed. Thus, the greater demand for goods and services causes the prices of goods and services to increase. The increase in the price level, in turn, increases the quantity of money demanded because people are using more dollars for every transaction. Eventually, the economy reaches a new equilibrium.
What is the classical dichotomy?
The classical dichotomy is the separation between nominal variables, measured in units of money, and real variables, measured in physical units. For example, nominal GDP is a nominal variable because it measures the dollar value of the economy’s output of goods and services; real GDP is a real variable because it measures the total quantity of goods and services produced and is not influenced by the current prices of those goods and services.
What is monetary neutrality?
Monetary neutrality is the irrelevance of monetary changes for real variables. Changes in the supply of money, according to classical analysis, affect nominal variables but not real ones. When the central bank doubles the money supply, the price level doubles, the dollar wage doubles, and all other dollar values double. Real variables, such as production, employment, real wages, and real interest rates, are unchanged. The dollar, like the yard, is merely a unit of measurement, so a change in its value should not have real effects.
What is the velocity of money?
The velocity of money refers to the speed at which the typical dollar bill travels around the economy from wallet to wallet.
What is the quantity equation?
The equation MV = PY, which relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services. It relates the quantity of money (M) to the nominal value of output (P × Y). The quantity equation shows that an increase in the quantity of money in an economy must be reflected in one of the other three variables: The price level must rise, the quantity of output must rise, or the velocity of money must fall.
What is the inflation tax?
The revenue the government raises by creating money. When the government prints money, the price level rises, and the dollars in your wallet become less valuable. Thus, the inflation tax is like a tax on everyone who holds money.
What is the FIsher effect?
When the inflation rate rises, so does the nominal interest rate as a one-to-one adjustment.
Nominal interest rate = inflation rate + real interest rate
What is the shoeleather cost of inflation?
The resources wasted when inflation encourages people to reduce their money holdings. The actual cost of reducing your money holdings is not the wear and tear on your shoes but the time and convenience you must sacrifice to keep less money on hand than you would if there were no inflation.
What are menu costs?
Firms change prices infrequently because there are costs to changing prices. Costs of price adjustment are called menu costs, a term derived from a restaurant’s cost of printing a new menu. Menu costs include the costs of deciding on new prices, printing new price lists and catalogs, sending these new price lists and catalogs to dealers and customers, advertising the new prices, and even dealing with customer annoyance over price changes.
What are the six costs of inflation identified by economists?
Six costs of inflation: shoeleather costs associated with reduced money holdings, menu costs associated with more frequent adjustment of prices, increased variability of relative prices, unintended changes in tax liabilities due to nonindexation of the tax code, confusion and inconvenience resulting from a changing unit of account, and arbitrary redistributions of wealth between debtors and creditors.
What is a recession?
a period of declining real incomes and rising unemployment
