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Is velocity constant? 1.Classicals thought V constant because didnt have good data 2.After Great Depression, economists realized velocity far from constant.

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Presentation on theme: "Is velocity constant? 1.Classicals thought V constant because didnt have good data 2.After Great Depression, economists realized velocity far from constant."— Presentation transcript:

1 Is velocity constant? 1.Classicals thought V constant because didnt have good data 2.After Great Depression, economists realized velocity far from constant

2 Liquidity Preference Analysis Derivation of Demand Curve 1.Keynes assumed money has i = 0 2.As i, relative R E on money (opportunity cost of money ) M d 3.Demand curve for money has usual downward slope 4.QD M = f(i; Y, P) Income Effect: Y => QD M at each i (D M ) Y => W => D M as medium of exchange and store of value Price Level Effect: P => QD M at each i (D M ) People care about purchasing power of money, real money balances = X = M/P

3 Chapter 19: The Demand for Money Theories of MD 1.Classical Theory (1900 Fisher) 2.Keynesian Theory 3.Quantity Theory (Friedman) Big Questions: 1.How is PY determined 2.Is MD = f (i) 3.Does M => P => Y P Y AD AS PxY i Q of M MD = f (Y, P) MD = f (i;Y, P)

4 M x V = P x Y M/M + V/V = P/P + Y/Y P/P M/M + V/V - Y/Y If V/V = 0, Then P/P M/M - Y/Y If M/M > Y/Y Then P/P > 0 If M/M = Y/Y Then P/P = 0 Milton Friedman: Inflation is everywhere and always a monetary phenomenon Equation of Exchange (identity) Inflation Quantity Theory of Money (PY determined solely by Q of M) Irving Fishers assumption Velocity of Money = V (rate of money turnover) (link between M & PY) Classical School assumes W, i, & P flexible => Y = Y FE So M => P Or M/M => P/P

5 Quantity Theory of Money Demand M = (1/V) x P Y (in eqlm M = MD) MD = (1/V) x P Y MD = k x P Y Implication: MD not a fn of i MD is a fn. of PY (medium of exchange) MD is a fn. of tech./fin. innovation (1/10 and falling)

6 Keyness Liquidity Preference Theory 3 Motives/Components of MD 1.Transactions motive related to Y Checking accounts 2.Precautionary motive related to Y Savings accounts 3.Speculative motive A. related to W and Y B. negatively related to i Money market accounts

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16 Econ 330 Chapter 19 Homework Due Friday, April 18 Chapter 19 Questions & Applied Problems 2, 5, 7, 11, 14, 21, 24, 25


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