Economics 17

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  • Inflation & Price Stability
    • Classic Theory
      • When the price level rises, people have to pay more for the goods and services that they purchase
      • A rise in the price level lowers the value of money because unit of currency buys a smaller quantity of goods and services
      • Increased supply of money: supply to right, equilibrium falls, price rises
    • Costs of Inflation
      • Fall in Purchasin Power - as prices rise, so do incomes
      • Shoeleather costs - Inflation erodes the value of money that you carry in your pocket
      • Menu Costs - cost of changing prices
      • Inflation distorts relative prices and with it consumer decisions
      • Inflation discourages saving, so reducing funds for investment and future growth
      • Value of money falls. Causing a confused valuation of goods
    • In the short run there is a trade off between inflation and unemployment
    • A supply shock is an event that directly affects firms’ costs of production
    • To reduce inflation the central bank has to pursue contractionary monetary policy
      • To reduce inflation the central bank has to pursue contractionary monetary policy
      • A policy change that has the effect of reducing the natural rate of unemployment
        • shifts the long-run Phillips curve to the left.

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