1. Ch 28 Money Growth and Inflation I. Historic Look (p628)…inflation vs deflation hyperinflation

2. II. Classical Theory of Inflation a)P measured by CPI or GDP delator b)P measures number of dollars needed to buy basket of goods c)The Q of goods you can buy with one dollar = 1/P d)So….1/P is the value of money measured in terms of goods and services it buys e)So….as P rises,,,,,the value of money falls

3. III. Value of Money (Supply and Demand) Money Supply (Fed and banking system); MS is vertical because _____________ Money Demand :MD is downward sloping because __many___determinants: use of credit cards, interest rates, etc. --most impt. = price level the higher P = lower value of money = more money demanded to buy goods. --the higher P = people hold more money.

4. Value = 1/P Price Level 1/22 If P< Pe? If P > Pe? 1 4

5. Value = 1/P Price Level 1/22 1 4 Monetary Injection…immediate impact? : Surplus = ….. Spend or save (= more spending) = …increase AD…..but…? Ability to produce has not changed….so….. Creates rise in PL and increase in QD b/c now need more for every transaction

6. Q Theory of Money : Q of M available determines the PL Growth rate of Q of M determines Inflation Rate

7. Classical Dichotomy and Monetary Neutrality How do monetary changes affect other variables (production, employment, wages) David Hume classical dichotomy separates “real” and “nominal” variables

8. Applications Price of corn = $2/bushel …. = nominal But the “relative” price: bushel of corn = two bushels of wheat ….. = real Dollar prices are nominal ; relative prices are real Ex: real wage = real variable

9. Analogy If MS doubles, all P double and the value of a dollar falls by ½ If change yard from 36 to 18 inches: all measured distances (nominal) would double, but the actual distances (real) would not change

10. Long run vs. Short run 4 th paragraph p 634 Monetary changes do effect short run But in long run – only negligible affects on real variables Monetary Neutrality – Changes in MS do not affect real variables Changes in MS do not affect : a. Productivity and factor supplies b. Real interest rates c. Real wages