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Principles of Microeconomics Chapter 11 Summary, Summaries of Microeconomics

Carleton UniversityMicroeconomics

Summary of chapter 11 of principles of microeconomics, eighth Canadian edition. Including key concepts, graphical evidence, and formulas

Typology: Summaries

2019/2020

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Macroeconomics Chapter 11 – The Money Growth and Inflation
Some important notes
• Inflation: increase in the overall level of prices
• Deflation: fall in the overall level of prices
• The economy’s overall price level can be viewed in two ways:
– The price of a basket of goods and services
– A measure of the value of money (our focus in this chapter)
MS and MD
• Money supply (MS) is determined by BoC
• Money demand (MD) reflects how much wealth people want to hold in liquid form
(liquidity preference)
• MD~ P, interest rate (Ch. 15), credit card, etc.
Price level and value of money
The value of money is determined by MS and MD:
• MS is controlled (fixed) by BoC
• MD reflects how much will people want to hold in liquid form, sometimes referred to as
liquidity preference
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Macroeconomics Chapter 11 – The Money Growth and Inflation

Some important notes

  • Inflation: increase in the overall level of prices
  • Deflation: fall in the overall level of prices
  • The economy’s overall price level can be viewed in two ways:
    • The price of a basket of goods and services
    • A measure of the value of money (our focus in this chapter) MS and MD
  • Money supply (MS) is determined by BoC
  • Money demand (MD) reflects how much wealth people want to hold in liquid form (liquidity preference)
  • MD~ P, interest rate (Ch. 15), credit card, etc. Price level and value of money The value of money is determined by MS and MD:
  • MS is controlled (fixed) by BoC
  • MD reflects how much will people want to hold in liquid form, sometimes referred to as liquidity preference

Monetary injection Let’s imagine the BoC doubles the MS by printing some dollar bills. What are the effects of a change in monetary policy? Money is neutral

  • Classical dichotomy: the theoretical separation of nominal (in C$) and real variables (in unit)
  • Two groups of economic variables:
    • Nominal variables: GDP, wages, price
    • Real variables: real GDP, real wages, relative price
  • Monetary neutrality: the proposition that changes in the money supply do not affect real variables Quantity theory of money
  • A theory asserting that:
  • the quantity of money available determines the price level and.
  • the growth rate in the quantity of money available determines the inflation rate

Observations

  • V is stable over time
  • When BoC changes MS, it causes proportionate changes in the nominal GDP (PY)
  • From chapter 7, Y~AF (K,L,H, N), so M does not affect Y – money is neutral
  • In this case, M affects P

4 Hyper-inflations Hyperinflation: inflation that exceeds 50% per month Inflation tax

  • When government raises revenue by printing money, it is said to levy an inflation tax
  • Printing money will lead to hyperinflation
  • The inflation ends when the government institutes fiscal reforms

Fisher effect Increase in MS will lead to higher inflation rate and higher nominal interest rate:

  • The one-for-one adjustment of the nominal interest rate to the inflation A fall in purchasing power?
  • Inflation does not in itself reduce people’s real purchasing power if nominal incomes tend to keep pace with rising prices
  • There are costs associated with inflation
  • Shoe leather costs
  • Menu costs Relative price variability
    • Relative prices vary more than they otherwise would in the presence of inflation
    • We rely on relative prices to allocate scarce resources
    • The cost of confusion and inconvenience to accountants and investors Inflation and Tax burden on saving Which economy provides better after- tax interest rate?
    • Inflation increases tax burden