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Review of The Previous Lecture
Review of The Previous Lecture
Review of The Previous Lecture
If policymakers expand aggregate demand, they can lower unemployment, but only at
the cost of higher inflation.
If they contract aggregate demand, they can lower inflation, but at the cost of
temporarily higher unemployment.
The Phillips curve illustrates the short-run relationship between inflation and
unemployment.
The greater the aggregate demand for goods and services, the greater is the
economys output, and the higher is the overall price level.
Lecture 19
Lecture Outline
Because prices are defined in terms of money, we need to consider the nature
of money, the supply of money, and how it is controlled.
Money: Money is the stock of assets that can be readily used to make
transactions.
Money
Money: functions
1.medium of exchange
we use it to buy stuff
2. store of value
transfers purchasing power from the present to the future
3. unit of account
the common unit by which everyone measures prices and values
Money: types
1. fiat money
has no intrinsic value
example: the paper currency we use
2. commodity money
has intrinsic value
examples: gold coins,
Money
The money supply & monetary policy
The money supply is the quantity of money available in the economy.
Monetary policy is the control over the money supply.
The central bank
Money
Money supply measures, April 2002
_Symbol
Assets included
Amount (billions)_
C
Currency
$598.7
M1
C + demand deposits,
travelers checks,
other checkable deposits
1174.0
M2
5480.1
M3
8054.4
T
V
M
where
V = velocity
T = value of all transactions
M = money supply
Use nominal GDP as a proxy for total transactions.
Then,
P Y
V
M
(M/P )d = k Y
quantity equation: M V = P Y
The connection between them: k = 1/V
When people hold lots of money relative to their incomes (k is high), money
changes hands infrequently (V is low).
V V
With this assumption, the quantity equation can be written as
M V P Y
How the price level is determined:
With V constant, the money supply determines nominal GDP (P Y )
Real GDP is determined by the economys supplies of K and L and
the production function (chap 3)
The price level is
P = (nominal GDP)/(real GDP)
M V
P Y
M
V
P
Y
The quantity theory of money assumes
V
V is constant, so
= 0.
V
Let (Greek letter pi) denote the inflation rate:
P
P
M
P Y
M
P
Y
Summary
Money