Economics Chapter 27 Money growth and inflation
The classical theory of inflation
The level of prices and the value of money
Inflation is an economy-wide phenomenon that concerns, first and foremost, the value of the
economy’s medium of exchange.
The economy’s overall price level can be viewed in two ways:
- price level as a price of a basket of goods and services
(when price rises, people have to pay more for the goods and services they buy)
- a measure of the value of money
(a rise in price level means a lower value of money, because each unit of money now buy a
smaller quantity of goods and services)
Money supply, money demand and monetary equilibrium
What determines the value of money? This is supply and demand.
But what are the determinants of supply and demand?
Quantity of money supplied – a policy variable that the central bank controls.
Quantity of money demanded – the average level of prices in the economy.
What ensures that the quantity of money the central bank supplies, balances the quantity of money
people demand?
Long run -> the overall price level of prices adjusts to the level at which the demand of money equals
the supply.
The supply curve is vertical, because
the quantity of money supplied is
fixed by the central bank.
The demand curve is downward
sloping, because people wat to hold
a larger quantity of money when
each euro buys less.
If the price level is above the
equilibrium level, people will want
to hold more money than the
central bank had created, so the
price level must fall to balance
again.
If the price level is below the
equilibrium level, people will want to hold less money than the central banks had created, and the
price level must rise to balance again.
The classical theory of inflation
The level of prices and the value of money
Inflation is an economy-wide phenomenon that concerns, first and foremost, the value of the
economy’s medium of exchange.
The economy’s overall price level can be viewed in two ways:
- price level as a price of a basket of goods and services
(when price rises, people have to pay more for the goods and services they buy)
- a measure of the value of money
(a rise in price level means a lower value of money, because each unit of money now buy a
smaller quantity of goods and services)
Money supply, money demand and monetary equilibrium
What determines the value of money? This is supply and demand.
But what are the determinants of supply and demand?
Quantity of money supplied – a policy variable that the central bank controls.
Quantity of money demanded – the average level of prices in the economy.
What ensures that the quantity of money the central bank supplies, balances the quantity of money
people demand?
Long run -> the overall price level of prices adjusts to the level at which the demand of money equals
the supply.
The supply curve is vertical, because
the quantity of money supplied is
fixed by the central bank.
The demand curve is downward
sloping, because people wat to hold
a larger quantity of money when
each euro buys less.
If the price level is above the
equilibrium level, people will want
to hold more money than the
central bank had created, so the
price level must fall to balance
again.
If the price level is below the
equilibrium level, people will want to hold less money than the central banks had created, and the
price level must rise to balance again.
