Money and Prices

1. Money market

• Value of money = 1/p
• Money supply
• Money (transactions) demand - positive relationship between price and the quantity demanded of money
• Long run: p* | Qd = Qs

2. Quantity theory of money

• ↑MS → surplus of money → X → ↓1/p (↑p) ... and vice versa
• Intuition: X = spend the extra money, deposit it in bank (loans → spending)
• Ability to supply goods and services has not changed (chapter 25)

3. Classical dichotomy and money neutrality

• Classical dichotomy - the theoretical separation of nominal and real variables
• e.g., real = inflation adjusted prices, output; nominal = prices
• The monetary system explains changes in nominal variables
• Money neutrality - changes in the money supply do not affect real variables (a long run theory)
• V = velocity of money (the rate at which money changes hands) = (PY)/M
• Quantity equation: MV = PY
• Quantity theory of money: MV = PY

4. Inflation

• Hyperinflations
• Inflation tax
• Fisher effect

5. Costs of Inflation

• Shoeleather costs - the costs of going to the bank more frequently
• Menu costs - the costs of changing prices
• Distortion of relative prices
• Tax distortions
• Confusion and inconvenience
• Arbitrary redistributions of wealth