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Is velocity constant? 1. Classicals thought V constant because didn’t have good data 2. After Great Depression, economists realized velocity far from constant

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**Liquidity Preference Analysis**

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

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**Chapter 19: The Demand for Money**

Theories of MD Classical Theory (1900 Fisher) Keynesian Theory Quantity Theory (Friedman) Big Questions: How is PY determined Is MD = f (i) Does DM => DP => DY AS P AD PxY Y i MD = f (Y, P) MD = f (i;Y, P) Q of M

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**(rate of money turnover) W, i, & P flexible => Y = YFE**

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

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**Implication: MD not a fn of i MD is a fn. of tech./fin. innovation**

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)

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**Keynes’s Liquidity Preference Theory**

3 Motives/Components of MD Transactions motive —related to Y Checking accounts 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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07 06 01 95 00 98 97 96 99 05 04 02 03 92 94 93

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**Chapter 19 Homework Due Friday, April 18**

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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The Theory of Aggregate Demand Classical Model. Learning Objectives Understand the role of money in the classical model. Learn the relationship between.

The Theory of Aggregate Demand Classical Model. Learning Objectives Understand the role of money in the classical model. Learn the relationship between.

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