Answer Macroeconomics

Money and inflation

01 Money 1
Functions of money:
Medium of exchange
Unit of account
Store of value

02 Money 2
/ Motives for holding money:
Transactions motive / dependent on income
Precautionary motive / dependent on income
Speculative motive / dependent on interest rates

03 Money market
Interest rates (r)
Supply 2 Supply 1

r2
r1
Demand

Money
Interest rates rise.

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04 Money market, GDP and inflation

Interest rates (r)
Supply 1 Supply 2

Price level (PL)

Aggregate supply

PL 2

r1

Aggregate
demand 2

PL 1
Demand

Aggregate demand 1
Money

GDP
1

Money supply rises Interest rates fall Aggregate demand (investment) rises
GDP and the price level rise

05 Money creation 1
Money (deposits) = 5000 *

1
1
1
= 5000 * = 5000 *
= 25000
1 - (1 - r)
r
0.2

06 Money creation 2
Cash ratio rises:
Reserve ratio falls:

Money multiplier decreases.

Money multiplier increases.

07 Inflation 1

Shoeleather costs (= costs of holding less cash)

Menu costs (= costs of changing prices)
In the case of unexpected inflation:
Arbitrary change in the redistribution of income and wealth
People with nominal assets (liabilities) lose (gain).

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08 Inflation 2
Price level (PL)

Aggregate supply 2
Aggregate
supply 1

PL 2
PL 1

GDP
Price level rises, GDP falls (Stagflation).

09 Price level
Increase in prices =

108.2 - 105.0
* 100 = 3.05 %
105.0

10 Quantity theory of money

M*V=Q*P
If velocity of money and real output (full employment) are constant, a rise in money supply
will cause an increase in price level.

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