What is money? Money is a generally acceptable liquid asset that could be used to discharge liability.

Functions of money are: medium of exchange

Functions of money are: medium of exchange unit of account

Functions of money are: medium of exchange unit of account store of value

Functions of money are: medium of exchange unit of account store of value Standard of deferred payment

Quantity Theory of Money Money * Velocity=Price*Output

Quantity Theory of Money Money * Velocity=Price*Output M*V =P*y

Quantity Theory of Money: Cambridge Equation Named after Alfred Marshall of Cambridge University in England. (M d /P) = k *y Where k=(1/P)

Quantity Theory of Money: Cambridge Equation Named after Alfred Marshall of Cambridge University in England. (M d /P) = k *y where: M d = Money demand k = fraction of income that people hold as money y = real output of goods and services

Quantity Theory of Money: Cambridge Equation Named after Alfred Marshall of Cambridge University in England. (M d /P) = k *y M d = k * P * y

Quantity Theory of Money: Cambridge Equation In equilibrium, demand and supply of money must be equal. M s = M d M d = k * P * y M s = k * P * y or y d = M s / k * P

Aggregate Demand y P yd = M S / (k*P) P1 P2 y1y2

Equilibrium Price and Output y P yd = M S / (k*P) P1 y1 ysys

Causes of Inflation in the Classical Model Inflation could come from Supply side

Causes of Inflation in the Classical Model Inflation could come from Supply side Demand side

Supply Side Inflation y P yd = M S / (k*P) P1 y1 y s1

Supply Side Inflation y P yd = M S / (k*P) P1 y1 y s1 y s2 y2 p2

Demand Side Inflation y P yd1 = M S / (k*P) P1 y1 y s1

Demand Side Inflation y P yd1 = M S / (k*P) P1 y1 y s1 yd2 = M S / (k*P) P2

Neutrality of Money Variation in the money supply does not influence real variables (real sector) of the economy such as output and employment. It only affects price level.