Econ 2

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  1. Equation of Exchange
    • M^s x V= P x Y
    • M^s- money supply
    • V- velocity of money
    • P- price level
    • Y- GDP
  2. Assumptions of Classical Model (QT)
    • 1. V is constant (spending habits of households are stable)
    • 2. People demand money for transaction purpose.
    • 3. Y is at Y*P (self adjusting economy)
  3. The Monetarist Transmission Mechanism
    • M^s to Transactions to AD to Prices - everything
    • Restrictive monetary policy to limit inflationary effects
  4. Keynesian Liquidity Preference Theory of Money
    • Demand for money-
    • Following the monetarist keynesians saw a transaction demand for money
  5. Keynesian Speculative Demand
    • Money is viewed as an asset (or alternative form of wealth)
    • Other assets we will call bonds
    • Viewing money as an asset- if we had money we incur an opportunity cost which is the rate of return on bonds.
  6. 4 Determinants of Demand for Money
    • 1. Changes in the price level- if prices level increases than MD will increase. VV
    • 2. Changes in GDP- if GDP increases then MD will increase. VV
    • 3. Changes in technology- the atm reduces MD beause they reduce our demand for cash.
    • 4. Changes in institutions- when regulation Q was eliminated in 1980- interest rates were then paid on demand deposites
  7. Fed increases Ms
    • People have surplus money
    • They use that money to purchase bonds
    • As the purchase bonds- the price of bonds rise
    • As the price of bonds increase, rules of return on bonds fall.
  8. New Classical
    • Economy is self adjusting.
    • Says law- supply creates its own demand.
    • Policy minimum government intervention.
  9. New Keynesian
    • Economy not self adjusting.
    • AD can be deficient
    • Government should intervene to stimulate AD
  10. Milton Friedman
    • Reformulate the Q theory of money.
    • He incorporated the speculative demand for money into the model.
    • Argued speculative demand is not as important as transactions demand.
    • Central bank should follow a policy rule.
    • Look at equation.
  11. Natural Rate or Fooling Model
    • Assume
    • 1. Workers mispercieve movements in the price level.
    • 2. The economy is at capacity (y=y*p; unemployment = natural rate.)
    • 3. The policy makers do not recognize the natural rate of unemployment.
  12. Rational Expectations Model- Robert Lucas
    • Both workers and employers can misprecieve movements in the price levels.
    • Both workers and employers would work to develope rational expectations where they accurately predict movements in the price level.
    • Workers and employers are rational actors so they will continually seek information to accurately predict prices.
  13. Real Business Cycle
    • Finn K. and Edward Prescott
    • The business represents fluctuation in the potential GDP.
    • To this point we have argued the business cycle is denotations in actual from potential GDP.
    • Policy- nothing can be done on the demand side to stabalize the economy. Monetary and fiscal policy are ineffective.
  14. New Keynesian Economics
    • Do sticky prices gum up the economy.
    • DEveloped hypothesis exploring why prices in the economy are rigid.
    • Menu costs, explicit and implicit contracts.
    • See SRAS as being stable. So if there is a shock that reduces AD. The economy can become stuck below full employment. GRAPH
Card Set
Econ 2
Section 2
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