Money Supply and Demand

Money Supply and Demand

• Price Level (P) - Measured using the CPI or GDP Deflator
• Value of Money = 1/P and this represents how much $1 is worth in terms of goods and services.

• If there is a monetary injection (increase in money supply) the price level will

  increase

  ---

  and the value of a dollar will

  decrease

  ---

  .
• Quantity Theory of Money - a theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate
• Nominal Variables - variables measured in monetary units
• Real Variables - variables measured in physical units. Example: If the price of books are $20 and price of shirts are $40 those are

  nominal

  ---

  prices. The real (or relative) price of one shirt is

  2

  ---

  books.
• Classical Dichotomy - the theoretical separation of nominal and real variables
• Monetary Neutrality - the proposition that changes in the money supply do not affect real variables. From the example above, if money supply increases and the prices of both products double to $40 for books and $80 for shirts, the real price of one shirt is still

  2

  ---

  books.