Transcript Money and Price Level

MONEY AND PRICE LEVEL
PAPER MONEY
Does Paper Money have any intrinsic value?
 What is money then?
 Why is it important?

If there was no money then we would have to
barter
 For barter to work – trade is said to require the
double of coincidence of wants.

THE HISTORY OF MONEY
Mesopotamian civilization developed a large
scale economy based on “Commodity money”
 Many other cultures also developed commodity
money
 Tobacco in America, Shells in India, Spices in
Europe, Alcohol in New South Wales
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If you were in prison, what would be good forms
of money to smuggle in.
3 IMPORTANT FUNCTIONS OFMONEY

Medium of exchange
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Unit of Account
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Anything that facilitates trade by being generally
accepted by all parties in payment for goods and
services.
A common unit for the measuring the value of every
good and service.
Store of Value

Anything that retains its purchasing power over
time.
THE CHARACTERISTICS
OF
COMMODITY
MONEY
Durable
 Portable
 Divisible
 Uniform Quality

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Gresham’s law – people tend to horde good money
and trade away the rest.
Low opportunity cost
 Value of money should not fluctuate erratically.
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WHAT IS COMMODITY MONEY
Money that takes the form of a commodity with
intrinsic value
 Intrinsic means that the item would have value
even if it was not used as money.
 Money without intrinsic value is known as Fiat
Money

TOO MUCH MONEY VS TOO LITTLE MONEY
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The fall of the Soviet Union
The ruble experienced hyper inflation.
 Value of the ruble fell dramatically
 Russians demanded other hard currency
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Sanctions against Panama
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The Panamanians depended on the dollar
The US did not permit them to trade.
People started hording dollars.
Started taking money out of banks.
Finally people resorted to barter
Panama’s GDP as a result fell 30% in 1988
WHY IS INFLATION UNPOPULAR
Higher inflation means you have to spend more?
 When viewed from the income side –


Higher inflation means
You get paid more
 You get more for your factors of production.

UNLESS PRODUCTIVITY INCREASES
HIGHER WAGES MEAN HIGHER PRICES
 Who are hurt the most because of inflation

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Individuals whose incomes are fixed in nominal
terms – Pensions, EPF
FACTORS OF INFLATION
Increase in the money supply
 Decrease in the demand for money
 Decrease in aggregate supply of goods and
services.
 Increase in aggregate demand for goods and
services.

COST PUSH INFLATION
Basically means that prices have been pushed up
due to the increase in the 4 factors of production.
 Higher production costs
 Companies cannot maintain profit margins
 Costs are passed on to the consumer
 Prices rise
 Rising Prices mean inflation has increased.
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DEMAND PULL INFLATION
Occurs when there is an increase in aggregate
demand
 When the four sectors of the economy increase
their consumption

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Households, Government, Firms, Foreign buyers
They bid prices up
 Increased prices = inflation.
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IS INFLATION BAD?
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Practically every economist will tell you that
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a little bit of inflation is a good thing
a lot of inflation is a bad thing
A little bit of inflation is like a tax on idle money. It
prompts people to get their money out of the mattress
(or low interest accounts) and put it to work on
investments.
A lot of inflation prompts people drives money out of
economy-driving investments and into inflationproofing investments (gold which does nothing for the
economy).
Deflation makes idle money profitable so no one, not
the Fed or economists, wants to see deflation. If
deflation was a risk today, you would see the Fed
trying to fight it.
THANK YOU