week 10sloch12 13
TRANSCRIPT
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PowerPoint to accompany
Money andInflation
Week 10Chapters 12& 13
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Sloman: Principles Of Economics 3e 2010 Pearson Australia
Learning Objectives
12.1 The meaning and functions of money What isthis thing called money?
12.2 - The financial system in Australia Where dobanks and other financial institutions fit in?
12.3 - The supply of money How is it measured andwhat determines its size?
12.4 The demand for money How much money dowe want to hold at any one time?
12.5 Equilibrium What effect does the demand andsupply of money have on interest rates?
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Money its meaning and functions
The functions of money
medium of exchange
means of evaluation or measure of value
means of storing wealth
Standard of deferred payments
What should count as money?
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Australias Financial System
The role of the financial sector financial intermediaries
expert advice
expertise in channelling funds
maturity transformation
risk transformation
transmitting payments
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Banks
assets and liabilities
liabilities deposits
assets loans; currency; deposits with theReserve Bank of Australia (RBA)
Non-bank financial intermediariescredit unions, building societies, financecompanies
Australias Financial System
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Sloman: Principles Of Economics 3e 2010 Pearson Australia
Liabilities %
Deposits 74.3Bills accepted 6.5Other liabilities 19.2
100.0
Assets
Coins, notes, deposits with RBA 0.5Loans and advances
Residential 37.7
Personal 6.3Commercial 27.3Bills receivable 4.8
All other assets 23.4100.0
Assets & Liabilities of AustralianBanks, 2006
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Assets of Australiasfinancial institutions, 2009
(Table 12.1)
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The Reserve Bank of Australia: functions
issues notes
acts as a bank
holds the official foreign currency reserves
acts as a lender of last resort
operates monetary policy
stability of currency
maintenance of full employment
economic prosperity and welfare of people in Australia
Australias Financial System
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The Money SupplyMeasuring the money supply
monetary base
notes, coins, deposits held by banks atthe RBA
broad money
cash in circulation, bank deposits,deposits in NBFIs
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Alternative Measures of theMoney Supply, 2009 (Table 12.2)
$billionCurrency 46
Plus current deposits with banks 201
= M1 $247bnPlus other deposits with banks 933
= M3 $1180bn
Plus net borrowing from the private sector
by NBFIs 67
= Broad money $1247bn
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Example of credit creation (I):Banks original balance sheet
(Table 12.3)
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Example of credit creation (II):Initial effect of an additional deposit
of $10 billion (Table 12.4)
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Example of credit creation (III):The full effect of an additional
deposit if $10 billion (Table 12.5)
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The Supply of Moneythe bank multiplier
1/L where L = liquidity ratio
banks liquidity ratio may vary
banks may choose a different liquidity ratiocustomers may not want to take up the credit onoffer
banks may not operate a simple liquidity ratio
some of the extra cash may be withdrawnfrom the banks
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The Supply of Money
Relationship between the money supplyand the rate of interest
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0
R a
t e o
f i n
t e r e s
t
Quantity of money
MS
The Supply of Money Curve:(a) Exogenous Money Supply
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R a
t e o
f i n
t e r e s
t
Quantity of money
The Supply of Money Curve:(b) Endogenous Money Supply
MS
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The Demand for Money
The 3 motives for holding money
transactions motive
precautionary motive
assets motive or speculative demandfor money
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The Demand for MoneyDeterminants of the size of the demand for
moneynominal GDP
frequency with which people are paid
financial innovations
speculation about future return on assets
rate of interest
The demand for money curve
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R a
t e o
f i n t e r e s
t
MD
Quantity of money
The Demand for Money
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Equilibrium
Equilibrium in the money market
equilibrium interest rate
where demand for money (M d) andsupply of money (M s) are equal
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R a
t e o
f i n t e r e s
t
Md
Quantity of money
MS
r e
Me
Equilibrium in the Money Market
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EquilibriumFull effect of changes in the money supply(Ms)
Ms r (interest rates)
r I
, C I , C AD , GDP , inflation
r exchange rate X , M
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Learning Objectives13.1 Aggregate demand How does the
aggregate demand for goods and services varywith the price level?
13.2 Aggregate supply How does theaggregate supply for goods and services vary withthe price level?
13.3 Equilibrium The determination of GDPand the price level?
13.4 Demand-pull inflation How changes inaggregate demand change the price level.
13.5 Cost-push inflation How increases in costs
cause inflation.
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Aggregate demand
0
P r i c e
l e v e
l
GDP
AD1
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A shift in aggregate demand (I)
0
P r i c e l e v e
l
AD1
AD2
GDP
Demandexpands from AD1 to AD2
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A shift in aggregate demand (II)
0
P r i c e
l e v e
l
AD0
AD1
AD2
GDP
Demandcontracts from AD1 to AD0
A t l
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0
P r i c
e l e v e
l
GDP
Aggregate supply AS1
A hift i t l
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P r i c
e l e v e
l AS2 AS1
GDP
A shift in aggregate supply
Supply expands
from AS1 to AS2
A hif i l
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P r i c e
l e v e
l AS2 AS1 AS3
GDP
A shift in aggregate supply
Supply contractsfrom AS1 to AS3
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P r i c e
l e v e
l
GDP
AS
AD
Equilibrium price and GDP
GDPe
Pe
P2
P1
At price level P 1 ,aggregate supplyexceeds aggregate
demand. Both contracttowards equilbrium
point.
At price level P 2, aggregate demandexceeds aggregate
supply. Both contracttowards equilbrium
point.
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P r i c e
l e v e
l
AS
AD1
P1
GDP1
AD2
P2
GDP2 GDP
Demand-pull inflation
f
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P r i c e
l e v e
l
GDP
AS1
AD
P1
GDP1
Cost-push inflation AS2
P2
GDP2
Interaction: demand pull and cost push inflation (I)
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AS1
AD1
P1
Interaction: demand-pull and cost-push inflation (I)
GDP
P r i c e
l e v e
l
AD2
P2
GDP2GDP1
STAGE I : If theeconomy is alreadyat full employment,GDP 1, an increasein demand to AD 2,
will pull priceshigher, from P 1 to P 2
. Notional GDPtemporarily expandsfrom GDP 1 to GDP 2
and equilibrium fromE1 to E 2.
E1
E2
Interaction: demand pull and cost push inflation (II)
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AS1
AD1
P1
Interaction: demand-pull and cost-push inflation (II)
GDP
P r i c e
l e v e
l AS2
AD2
P2
GDP2GDP1
STAGE II : Firms areunable to expand
real supply becausethe economy isalready at full
employment, GDP 1.In response to
shortage of supply,prices increase
further, from P 2 to
P 3. GDP returns toits original, reallevel, GDP 1.
P3
E2
E3
Interaction: demand pull and cost push inflation (III)
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Sl P i i l Of E i 3 2010 P A li
0
AS1
AD1
P1
Interaction: demand-pull and cost-push inflation (III)
GDP
P
r i c e
l e v e
l
AS2
AD2
P2
GDP2GDP1
STAGE III : Theinteraction of
excessive demandand shortage of supply continues,
pushing prices evenhigher but withoutinducing any real growth in GDP.P3 E3
AD3
AS3
P4
E5
E4