Answer Macroeconomics

2 Money and inflation

01 Money 1

Functions of money:
 Medium of exchange
 Unit of account
 Store of value

02 Money 2

 /  Motives for holding money:

 Transactions motive / dependent on income
 Precautionary motive / dependent on income
 Speculative motive / dependent on interest rates

03 Money market

Interest rates (r)

Supply 2 Supply 1

r2

r1
Demand

Money
Interest rates rise.

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04 Money market, GDP and inflation

Interest rates (r) Price level (PL) Aggregate supply

Supply 1 Supply 2

r1 PL 2

PL 1 Aggregate
demand 2
Demand
Aggregate demand 1
Money GDP
1 2
Money supply rises  Interest rates fall  Aggregate demand (investment) rises 
GDP and the price level rise

05 Money creation 1
1 1 1
Money = 5000 * 1 - (1 - r) = 5000 * r = 5000 * 0.2 = 25000

06 Money creation 2
 Cash ratio rises: Money multiplier decreases.
 Reserve ratio falls: Money multiplier increases.

07 Inflation 1

 Shoeleather costs (= costs of holding less cash)

 Menu costs (= costs of changing prices)
 In the case of unexpected inflation:
Arbitrary change in the redistribution of income and wealth
 People with nominal assets (liabilities) lose (gain).

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08 Inflation 2

Price level (PL)

Aggregate supply 2
Aggregate
supply 1
PL 2
PL 1

GDP

The price level rises, GDP falls (Stagflation).

09 Price level

108.2 - 105.0
Increase in prices = 105.0 * 100 = 3.05 %

10 Quantity theory of money

M*V=Q*P

If velocity of money and real output (full employment) are constant, a rise in the money
supply will cause an increase in the price level.

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