Chapter 30

Chapter 30 discussed inflation and its causes/ effects. Inflation is the increase in the overall level of prices. Deflation is long periods where most prices fell. Hyperinflation is an extraordinarily high rate of inflation. When the overall price level rises, the value of money falls. In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply. At the equilibrium price level, the quantity of money that people want to hold exactly balances the quantity of money supplied by the Fed. The equilibrium of the money supply and money demand determines the price level and the value of money. Classical dichotomy is the theoretical separation of nominal and real variables. The difference between real and nominal variables is that real variables are measured in physical units, while nominal variables are measured in monetary units. To calculate the velocity of money, the equation V= ( P X Y ) / M. The quantity theory of money states that growth in the money supply is the primary cause of inflation. The inflation tax is like a tax on everyone who holds money. The Fisher effect is the one-for-one adjustment of the nominal interest rate to the inflation rate. The Fisher effect is a long-run perspective because inflation is unexpected and can't therefore be held in the short-run. Inflation does not in itself reduce people's real purchasing power. Shoeleather costs are the resources wasted when inflation encourages people to reduce their money holdings. The six costs of inflation are: shoeleather costs (reduced money holdings), menu costs (more frequent adjustment of prices), increased variability of relative prices, unintended in tax liabilities, confusing from changing unit of account, and arbitrary redistributions of wealth between creditors and debtors.