Inflation
Th percentage increas in prices from one year to the next year.
Measured using the cpi or the gdp deflator
Core inflation
Excludes food and energy: good with historically volatile price changes
More stable
Focuses on the underlying economy-wide inflation trend; not a temp price shocks
Headline inflation includes all of the good that the average urban sonsumer buys.
Deflation
Falling rpices
Occurs less often than inflation
The value of money: Definition and link to inflation
P= Price level
The price of a basket of goods and services, measured in money
Inflation drives prices up and drives the value of money down- M can buy
M/Pup = Value of moneydown
Classical theory of inflation = quantity theory of money
Inflation is therefore and economy wide phenonmenon that concerns the value money - the economy's mediumm of exchanges
When the overall price levels rises, the balue of money falls
The classical theory of inflation
The quantity theroy of money argues that changes in the money supply the auntity of money in circulation determine the price level and the value of money but do not affect real variables in the long run
Developed in the mid-1700s by Scottish philosopher david hume and the 9th centry classical economics
Advocated nore recently by milton friedman
The neutrality of money and real gdp
Recall the gdp is an accounting of all production, cincome and spending that takes place in a country over a given period
But measuring output in terms of money can be bad
For example while the nominal gdp would rise if zeros were added to every dollar, real would not change
Futhermore purchasing power does not change if all rpices change the same amount if both prices and income the annual wage doubles I can still buy exactly the same amoutnt of stuff
The idea that changes in the price level affect nominal values, but d not affect real outcomes/values in the economy is called the neutrality of money
Thus the quantity theory of money says that money is neutral in the long run
However, uncertainty about changing price levels does matter and money neutral only the long run
The quantity theory of money
Specifies the exact realtionship between the money supply, the price level and the value of money in the long run
It states that the quantity of money in existance determines the price level and the value of money
A change in the auntity of money causes an equal proportional change in the price level and a proportional change in the value of money in the opoosit direction
Growth in the auntity of money is the primary cause of inflation in the long run
We will study this using
A supply and demandmoney diagram
Equation
Quantity equation
Multiply both sides of the velocity definition by M to obtain the quantitty equation
P=M*V/Y
V = P*Y/M
Velocity
Price level
Quantity
Money supply
M*V = P*Y
The quantity equation relates the quantity of money to the nominal value of output
If V is constant and the money is neutral then changes in M affect only P
Inflation rate = 100%*(7.00-6.00)/6.00
16.67 percent
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