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Terms in this set (45)
decreases incomes & reduces the ability of debtors to pay off their debts.
To explain the long-run determinants of the price level and the inflation rate, most economists today rely on the
quantity theory of money.
When the price level falls, the number of dollars needed to buy a representative basket of goods
decreases, so the value of money rises.
The value of moeny falls as the price level
rises, because the number of dollars needed to buy a representative basket of goods rises.
If P denotes the price of goods and services measured in terms of money, then
1/P represents the value of moeny measured in terms of goods & services.
The supply of money is determined by
the Federal Reserve System.
With the value of money on the vertical axis, the moeny supply curve is
vertical because we assume the central bank controls the money supply.
The supply of money increases when
the Fed makes open-market purchases.
As the price level decreases, the value of money
increases, so people want to hold less of it.
When the money market is drawn with the value of money on the vertical axis, as the price level increases, what also increases.
the quantity of money demanded but not the quantity of money supplied.
When the money market is drawned with the value of money on the vertical axis, the money demand curve slopes
downward, because at higher prices people want to hold more money.
When the money market is drawn with the value of money on the vertical axis, an increase int he money supply shifts the money supply curve to the
right, raising the price level.
When the money market is drawn witht he value of money on the vertical axis, an increase in the money supply causes the equilibrium value of money
to decrease, while the equilibrium quantity of money increases.
If the Fed increases the money supply, then 1/P
falls, so the value of money falls.
In the 1970s, in response to recessions caused by an increase in the price of oil, the central banks in
purchasing bonds on the open market, which would have lowered the value of money.
When the money market is drawn witht he value of money on the vertical axic, if the Federal Reserve sells bonds, then the money supply curve
shifts left, causing the price level to fall.
Economic variables who values are measured in monetary units are called
Economic variables whose values are measured in goods are called
The price level is
On a given morning, Franco sold 40 pairs of shoes for a total of $80 at his shoe store.
The $80 is a nominal vairable. The quantity of shoes is a real variable.
The classical dichotomy refers to the idea that the supply of money
determines nominal variables, but not real variables.
According to the classical dichotomy, what is influenced by monetary factors?
Nominal interest rates.
Monetary neutrality means that a change in the money supply
does not change real variables. Most economists think this is a good description of the economy in the long run but not the short run.
The velocity of money is
the average number of times per year a dollar is spent.
If M= 4,000, P=1.5, and Y=6,000, what is the velocity?
According to the quantity equation, the price level would change less than proportionately with a rise in the money supply if there were also
either a rise in output or a fall in the rate at which money changes hands.
If Y and M are constant and V doubles, the quantity equation implies that the price level
The inflation tax refers to
the revenue a government creates by printing money.
Suppose the US unexpectedly decided to pay off its debt by printing new money. What could happen?
People who held money would feel poorer.
Prices would rise.
People who had lent money at a fixed interest rate would feel poorer.
(all of the above are correct)^
The claim that increases in the grouth rate of the money supply increase nominal interest rates but not real interest rates is known as the
The nominal interest rate is 4.5% and the inflations rate is .9%. What is the real interest rate?
If a country experienced deflation, then
the real interest rate would be grater than the nominal interest rate.
The Fisher effect says that
the nominal interest rate adjusts one for one with the inflation rate.
Suppose that monetary neutrality and the Fisher effect both hold and the money supply growth rate has been the same for a long time. Other things thae same a higher money supply growth would be associated with
both higher inflation and higher nominal interest rates.
Which helps to explain why the inflation fallacy is a fallacy?
Nominal incomes tend to rise at the same time that the price level is rising.
The inflation tax
is a tax on everyone who holds money.
The shoe leather cost of inflation refers to
the waste of resources used to maintain lower money holdings.
When inflation rises, the nominal interest rate
rises, and people desire to hold less money.
When inflation rises, firms make
more frequent price changes. The raises their menu costs.
If there is inflation, then a firm that has kept its price fixed for some time will have a
low relative price. Relative-price variability rises as the inflation rate rises.
Higher inflation makes relative prices
more variable, making it less likely that resources will be allocated to their best use.
In the U.S., taxes on capital gains are computed using
nominal gains. This is one way by which higher inflation discourages saving.
Assuming the Fisher Effect holds, and given U.S. tax laws an increase in inflation
does not change the real interest rate but reduces the after-tax real rate of interest.
Wealth is redistributed from creditors to debtors when inflation is
If people had been expecting prices to rise but in fact prices fell, then who would benefit?
lenders and people holding a lot of currency.
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