Money - Supply & Demand & Prices ECO 473 – Dr. Dennis Foster

Price = f(Supply, Demand) Supply – amount available now. – An objective fact: it is what it is. Demand – amount we want to buy. – Varies inversely with the price. – It is the subjective value we have. Equilibrium – absence of surplus/shortage Q D S P P3 P2 P1

Effects on Price  S will  P;  S will  P  D will  P;  D will  P Scarcity implies price; price implies rationing.  (  ) D will  (  ) S over time. Change isn’t in isolation: –  D(here) will  D(there) Can Demand increase every- where in unison? Q D S P P1 P3 D’ P2 S* S’

Central Proposition about Money Demand can rise for all goods only if … … our incomes rise & the amt. of money rises! What of economic growth? What of economic growth? – Increased supply will drive down prices at the current level of income. – Rising material standards of living. – No change in the money supply. Only 2 things can cause persistent inflation: Only 2 things can cause persistent inflation: – Decreasing supply of goods (?) – Increasing amount of money (!).

What determines the “price” of money? Supply & Demand!! – Supply is still objective. – Demand depends on our wanting to exchange. – “Price” is purchasing power (PPM). Loaf of bread is $2 PPB = $2, PPM = ½ (loaf/$) PPM = 1/(price level) Equilibrium – absence of surplus/shortage $ D S PPM PPM3 PPM2 PPM1

Effects on Price  S will  PPM (raise prices);  S will  PPM – Increasing supply of money causes inflation.  D will  PPM (raise prices);  D will  PPM Wanting to hold more money means spending less. Wanting to hold less money means spending more. Where does inflation come from? Where does inflation come from? – Persistent decrease in demand for money (?) – or persistent increase in supply of money (!) $ D S PPM PPM1 PPM2 S’ D’ PPM2

Money - Supply & Demand & Prices ECO 473 – Dr. Dennis Foster