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Macroeconomic Theory

by: Mrs. Carmelo Deckow

Macroeconomic Theory ECON 102

Mrs. Carmelo Deckow
GPA 3.97


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This 10 page Class Notes was uploaded by Mrs. Carmelo Deckow on Friday September 4, 2015. The Class Notes belongs to ECON 102 at University of California - Los Angeles taught by Staff in Fall. Since its upload, it has received 16 views. For similar materials see /class/177946/econ-102-university-of-california-los-angeles in Economcs at University of California - Los Angeles.

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Date Created: 09/04/15
Econ 102 Fall 2006 Lecture 23 0 Questions this lecture address What is the quantity theory ofmoney and is it right How did Milton Friedman modify the Quantity theory and how does this modi cation help explain in ation in low in ation countries 2 Three classical Monetary sts Economl mmme ms mammme 192A maer 19M 3 M lton Fnedman 15 responsxble for emng classical monetary theory In ation 15 always and everywhere a monetary phenomenonquot A Mndem Mnnetary Ecnnnm t Quantity Thenry M 7 kY Demandmvmuneyws pvupumuna m GDP m cunstam mphes AI39 M p M Y n auun enuaxs meme rm vea nmwm Msway n Wan me Quantity Thenry versinn 2 MvpY duem mnngshev k l wscaHedthevemmty chwcu Hun ns enuax a V m M Three High Inflation Countries Three Low In atio Countries Ilm lam mm mm mm mm quotmam mu m mummym m Milton Friedman s Theory Friedman stressed that k is not a constant It depends on the interest rate We will study this theory and see how it helps to explain inflation in both high and low inflation countries J Costs and Bene ts Why is holding money costly Answer because the stock of cash could be used to purchase commodities What benefits does money bestow Answer it is useful in exchange liquidity Wealth and Income p Total wealth Y X 139 Income Interest rate Principle of marginal utility Income is a ow that derives from wealth Three kinds of income Subjective income llow ofu ility Money income flow of dollars Real income ow of goods We divide our wealth between different categories to equate the marginal utility of subjective income across categories W Wealth tutalvvealth physicalvvealth 7 human Wealth 7 bundslenttufirms 7 muney 7 price level Types of wealth T W B M H p P P Bonds farm or physical Humquot wealth Wealth Money furm Bf Fluvv ufincomeis Fluvv uflncomeis equaltu physmaiweaim uvv cur rent minus Wagetimeslabur depreciatiun Equaim Fluvv Dr mo is supplied m the market interest rate times Bp W Wbenefit Dfusmg my in Wm Income to different types of wealth Three kinds of wealth Physical interest bearing wealth capital Money Human wealth Return to wealth Interest rent minus depreciation is the return to capital Utility ow of money is the return to money Wage is the return to human capital J What is the subjective income from holding money Money avoids the problem of double coincidence of wants Classical quantity theorists assumed that the flow benefit of holding money measured in real units is proportional to real income Friedman s version Milton Friedman assumed instead that the marginal utility yielded by money must be balanced againstthe income flow from interest bearing assets lfthe interest rate goes up then it may be beneficial to hold less money J The Cost of Holding Money If a household puts all of its physical wealth into interest bearing assets it can earn a real income stream of Wax If it chooses to put some of its wealth into money it loses iMp This term is called the uppummlty cast at building money YYquot X W The bene t of holding money In Friedman s theory there is a utility function that enables the household to compare the subjective benefit of the services of money to the real benefit of extra income UU KM P What the Household Does The huusehuid chuuses the WEB uney cumbinatiun Siope is i m m that maximizes utiiity me income An Example 1 M This is an exampie ofthe U108Yh1 g utiiity othoidingrnonews P extra income M W Y Y l This is the budget constraint his a parameter that measures the reiative importance of money to ubiin J W An Example 2 0U 7 h This is the utility gained i from Oldlng one extra uhtt 0Mp Mp mm This is the ll lCOme lost by holding ah extra uhtt of ey This is the utility lost by receiving one less uht of 1 W 7 K What the Household Does 0U 0U awayW The slope otthe The slo e of budget constraint an indifference we 0 J What the Household Does in the Example This is the slope of an indifference hY curve forthe Mp 7 example M h This is the demand l l for moneyforthe example W How does this compare with the crude Quantity theory P P 1 Crude Dummy Thaw Fmedman sversmn uf k 5 mam me Quarmty Theury k safunmun um h msa parameter 1 H the mteres L rate Indifference Curves for the Quantity Theory of Money S ope 5 me ncome This is the Propensity to Hold Money k am 192 1940 man man mun mmm mummy W Evidence for the Utility Theory of Money 3 1 years Percent per year D iBDEI iazn 194D iaen lean ZUDEI Time vi M lnterest rate ien scale VElDEl ur circulatiun rightscale How the quantity theory determines the price level Money stock determined by the Fed 7M p ky GDP determined by k assumed preferences Endu merits and cunstant W Emmy Summary of the lecture The quantity theory of money is a theory of money demand It is used to explain inflation We hold money because it is useful in exchan e Friedman s version of the quantity theory explains Why the velocity of circulation has changed over time J


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