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1

What do most economists believe about the QTM?

the QTM is a good explanation of the long-run behavior of inflation

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2

P

Price Level

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3

What does inflation do to money?

Drives up prices and drives down the value of money.

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4

Who developed the Quantity Theory of Money?

18th century philosopher David Hume and the classical economists

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5

What does the QTM assert?

that the quantity of money determines the value of money

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6

How is the QTM studied?

Supply-Demand Diagram, an equation

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7

Who determines the Money Supply in the real world?

the fed, banking system, and consumers

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8

Money Demand refers to…

how much wealth people want to hold in liquid form

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9

An increase in P

reduces the value of money, so more money is required to buy g&s

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10

1/P

Value of Money

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11

Nominal variables

measured in monetary units

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12

Real variables

measured in physical units

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13

relative price

the price of one good relative to (divided by) another

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14

real wage

** W** (nominal wage)/

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15

Classical dichotomy

the theoretical separation of nominal and real variables

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16

Hume and the classical economists suggested that

monetary developments affect nominal variables but not real variables

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17

If central bank doubles the money supply, Hume & classical thinkers contend all nominal variables

—including prices—will double

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18

If central bank doubles the money supply, Hume & classical thinkers contend all real variables

—including relative prices—will remain unchanged

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19

Monetary neutrality

the proposition that changes in the money supply do not affect real variables

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20

the real wage ** W**/

quantity of labor supplied & demanded does not change,total employment of labor does not change

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21

Most economists believe the classical dichotomy and neutrality of money

describe the economy in the long run.

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22

Velocity of money

the rate at which money changes hands

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23

Nominal GDP

P*Y

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24

M

money supply

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25

V

Velocity

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26

Velocity formula

V=YP/M

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27

Quantity equation

MV=PY

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28

Percentage change

(End-Start)/Start

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29

If real GDP is constant, then

inflation rate = money growth rate

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30

If real GDP is growing, then

inflation rate < money growth rate

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31

Economic growth increases

# of transactions

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32

Some money growth is

needed for these extra transactions

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33

Excessive money growth

causes inflation

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34

Hyperinflation

generally defined as inflation exceeding 50% per month

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35

Excessive growth in the money supply

always causes hyperinflation

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36

Large govt budget deficits led to the creation of

large quantities of money and high inflation rates

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37

When tax revenue is inadequate and ability to borrow is limited

govt may print money to pay for its spending

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38

inflation tax

printing money causes inflation, which is like a tax on everyone who holds money

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39

In the U.S., the inflation tax today accounts for

less than 3% of total revenue

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40

Fisher effect

an increase in inflation causes an equal increase in the nominal interest rate, so the real interest rate (on wealth) is unchanged

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41

The inflation tax applies to people’s holdings of money

not their holdings of wealth

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42

inflation fallacy

most people think inflation erodes real incomes

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43

Shoeleather costs

the resources wasted when inflation encourages people to reduce their money holdings

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44

What does shoeleather costs include?

the time and transactions costs of more frequent bank withdrawals

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45

Menu costs

the costs of changing prices (printing new menus, mailing new catalogs, etc.)

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46

Misallocation of resources from relative-price variability

Firms don’t all raise prices at the same time, so relative prices can vary, which distorts the allocation of resources

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47

Confusion & inconvenience

**Inflation changes the yardstick we use to measure transactions (**Complicates long-range planning and the comparison of dollar amounts over time)

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48

Tax distortions

Inflation makes nominal income grow faster than real income

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49

Taxes are based on

nominal income, and some are not adjusted for inflation

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50

inflation causes people to

pay more taxes even when their real incomes don’t increase

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51

Real IR= Nominal IR-Inflation

Nominal IR-Inflation

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52

Nominal IR=

(% paid in decimal)*Nom. IR

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53

We saw that money is neutral in

the long run, affecting only nominal variables

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