EC201 Intermediate Macroeconomics

Feb 3rd, 2012
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Ashford University
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In order to understand inflation we need to understand its possible link with money. “Classical Theory”: it is called classical because it assumes prices are flexible and markets clear. Classical economics is the economics prevalent after Adam Smith and since the beginning of 1930.

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EC201 Intermediate Macroeconomics2012/2013EC201 Intermediate MacroeconomicsLecture 3: Money and InflationLecture Outline: - Money: definition and functions - The quantity theory of money - The classical theory of inflation Essential reading: Mankiw: Ch. 4 1) Classical Theory of Inflation What causes inflation? According to Milton Friedman (Nobel Prize in economics 1976): "inflation is always and everywhere a monetary phenomenon".15% 12% 9% 6% 3%% change in CPI from 12 months earlierlong-run trend0% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005slide 11Therefore, in order to understand inflation we need to understand its possible link with money. "Classical Theory": it is called classical because it assumes prices are flexible and markets clear. Classical economics is the economics prevalent after Adam Smith and since the beginning of 1930. Those economists believed that markets were perfect and thanks to price flexibility the markets automatically adjust to booms and recession without any need for government intervention. Since prices are flexible here we are considering a theory that applies to the long run. In this lecture we focus on the long-run trend behaviour of prices and inflation. The factors that make inflation deviating from its trend in the short run will be studiedwhen will talk about Aggregate Supply and the Phillips Curve. The connection between money and prices: Inflation rate = the percentage increase in the average level of prices

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