Econ-Chapter 7 Flashcards
equation of exchange
shows the relationship between prices and the money supply
the only way people will spend more on ALL goods is if
there is more dollars to spend
MV=PQ
the output in the economy is bought by the money supply, which is spent and re-spent at a rate of V, this is the interpretation of the equation of exchange
money supply turning over
that any dollars put in our pockets or in our bank account came from somewhere, and they will go to somewhere , and they will go from there.
velocity
the average number of times that $1 turns over
what does M, P, and Q mean
P- price of the output and Q- is the amount of the output produced by the economy , and M- is the money supply
simple quantity theory
- developed by Irving Fisher and Ludwig von Mises
- starts the equation of exchange and adds:
- over a short time period, resources are limited, so output is limited
- the speed at which money moves through the economy is limited
the simple quantity theory assumes that in the short run
output and velocity are constant
the result of the simple quantity theory is that the price level and the money supply are
proportionally related
Milton Friedman
- founded the monetarist school of economics
- his book published in 1963- changed economics profession
Monetarism
begins with the equation of exchange, then softens the assumptions of the simple quantity theory
Friedman showed
- that velocity is stable and predictable
- output is not fixed, but that the economy has potential that it tends to move toward.
equation of exchange
MV=PQ
Friedman illustrates his ideas in “the helicopter drop of dollars”
in the short run their will be an increase in prices and quantity, but in the long run with higher prices, the real wage, the real price of a steak dinner, and all other real prices are the same as before. in the long run, the helicopter drop only causes inflation
secured loans
loans that have a less risky asset backing as they are crucial to society. example: homes
the pizza place example
you own a pizza place and all the prices in the economy double evenly, this means that you should still produce the same amount of goods as before, because inflation does not change production decisions
unanticipated inflation on a good you already possess a lot of
your wealth is higher
unanticipated inflation
borrowers gain and loaners loose-in fact , everyone who has a contract to pau with inflated dollars gains, while those who receive the inflated dollars loose , also those who are saving dollars loose
nominal interest rate
bank quote this which is the rate that is advertised which shows up on your finical statements
real interest rate
banks formulate their nominal interests rate based on what they expect inflation to be, aiming for this
Secured Loans
example : houses
these are loans that are backed by a real asset
unsecured loans
example: credit cards
these have nothing really backing the loan which means they are higher because it costs the company much more to administer the credit card, whose payments vary and changers continue to pile up and be paid off
As long as all prices rise or fall by the same amount and inflation is anticipated,..
inflation has no effect on the economy
problems with uneven inflation
- we don’t know the real worth of goods
- formation of bubbles in the economy
Without prices to tell them the about scarcity and other’s preferences then
unemployment and less buisness will be done
the idea that money creation fuels inflationary bubbles, which burst and cause unemployment was formulated by
the austrian economist Ludwig von Mises and Freidrich Von Hayek
Austrian economists view the overall spontaneous order of the market based on-
tastes, knowledge, and scarcity, all connected by prices-as stable.
Austrians say that the errors by central banks are the cause of
destabilization in the economy
the state often spends more than it taxes, so it borrows from
private citizens, from companies, and from other governments by selling its bonds to them
Monetizing the debt
when a centeral bank, such as the fed, attempts to assist the state in its borrowing by purchasing debt in return for dollars
money creation causes inflation, which destabilizes the economy, but
inflation assists the state in financing its borrowing
inflation
borrowers gain and lenders lose
The inflationary tax
when the state creates inflation in order to reduce the value of its debt
US Economy from 1800-1979
- government issued greenbacks, would not exchange them for gold (the main issue of currency at the time)
- then the greenbacks were used to exchange with gold
- the fed was created
Milton Friedman monetizing the debt
- his predictions came true, inflation brought unemployment
- inflation destabilized the economy
- Paul Volcker tightened money supply, and caused a recession
- this caused accounts to be worth half as much, and savers are lenders who then lose due to the inflationary tax
