Download money_increases

LECTURE 3
MONEY SUPPLY INCREASES
THE MACRO ECONOMIC MODEL
Introduction to Economics
Charles R. Plott
California Institute of Technology
I
a
Spending
I1+a1
I1
Y1
i
i
I1
a1
I
UNKNOWNS
.Y income
.C consumption
.I investment
.i interest rate
.P price level
.L employment
.MD money demand
.MDT transaction demand P
for money
.MDS speculative demand
for money
.w nominal wages level
GIVENS
G Government spending
X net exports
M nominal money supply
b marginal propensity to
consume
EQUATIONS
.Y=C+I+G+X
.C=a(i)+bY
.I=I(i)
.M/P = MD
.MD=MDT+MDS
.MDT = MDT(Y)
.MDS = MDS(i)
.DL(w/P)-SL(w/P)=0
.L=SL(w/P)
.Y=F(L,..)
Y2
Y
i
i
a
Y
MD
MDT
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
EXERCISE #3
THERE IS A SHIFT IN THE
MONEY SUPPLY.
MONEY SUPPLY INCREASES.
A MONETARY INDUCED
INFLATION
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
Aggregate demand exceeds
aggregate supply causing price
increases. The price increase
lowers real wages. The lag in
expectations of price increases
in the labor market expands the
system beyond full
employment and GDP is above
potential GDP.
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
Increasing prices cause a decrease in
the real money supply. Less real
money puts upward pressure on
interest rates, choking off investment.
The decrease in spending is a fall in
aggregate demand, bringing it into
line with aggregate supply.
In the labor market wages adjust to
prices so real wage returns to the full
employment level and GDP moves
back to potential GDP.
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P