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Money and Price Level

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  1. Money and Price Level

  2. 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.

  3. 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 • If you were in prison, what would be good forms of money to smuggle in.

  4. 3 important functions ofmoney • Medium of exchange • Anything that facilitates trade by being generally accepted by all parties in payment for goods and services. • Unit of Account • A common unit for the measuring the value of every good and service. • Store of Value • Anything that retains its purchasing power over time.

  5. The characteristics of Commodity money • Durable • Portable • Divisible • Uniform Quality • Gresham’s law – people tend to horde good money and trade away the rest. • Low opportunity cost • Value of money should not fluctuate erratically.

  6. 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

  7. Too much money vs Too little money • The fall of the Soviet Union • The ruble experienced hyper inflation. • Value of the ruble fell dramatically • Russians demanded other hard currency • Sanctions against Panama • 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

  8. 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 • Individuals whose incomes are fixed in nominal terms – Pensions, EPF

  9. 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.

  10. 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.

  11. Demand pull inflation • Occurs when there is an increase in aggregate demand • When the four sectors of the economy increase their consumption • Households, Government, Firms, Foreign buyers • They bid prices up • Increased prices = inflation.

  12. Is inflation bad? • Practically every economist will tell you that  • 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 inflation-proofing 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.

  13. Thank you