Inflation
30
Copyright © 2004 South-Western
The Meaning of Money
• Money is the set of assets in an economy that
people regularly use to buy goods and services
from other people.
Value of Price
Money, 1/P Money supply Level, P
(High) 1 1 (Low)
3
/4 1.33
A
/
12 2
Equilibrium Equilibrium
value of price level
money
14
/ 4
Money
demand
(Low) 0 (High)
Quantity fixed Quantity of
by the Fed Money
Value of Price
Money, 1/P MS1 MS2 Level, P
(High) 1 1 (Low)
1. An increase
3
/4 in the money 1.33
2. . . . decreases supply . . .
the value of
3. . . . and
money . . . A
12
/ 2 increases
the price
level.
B
14
/ 4
Money
demand
(Low) (High)
0 M1 M2 Quantity of
Money
V = (P Y)/M
• Where: V = velocity
P = the price level
Y = the quantity of output
M = the quantity of money
Indexes
(1960 = 100)
2,000
Nominal GDP
1,500
M2
1,000
500
Velocity
0
1960 1965 1970 1975 1980 1985 1990 1995 2000
Index Index
(Jan. 1921 = 100) (July 1921 = 100)
100,000 100,000
Price level
Price level
10,000 10,000
Money supply
Money supply
1,000 1,000
100 100
1921 1922 1923 1924 1925 1921 1922 1923 1924 1925
Index Index
(Jan. 1921 = 100) (Jan. 1921 = 100)
100,000,000,000,000 10,000,000
Price level
1,000,000,000,000 Price level
Money 1,000,000
10,000,000,000
100,000,000 supply 100,000 Money
1,000,000 supply
10,000
10,000
100 1,000
1 100
1921 1922 1923 1924 1925 1921 1922 1923 1924 1925
Percent
(per year)
15
12
Nominal interest rate
Inflation
3
0
1960 1965 1970 1975 1980 1985 1990 1995 2000
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Confusion and Inconvenience