Name Section Subject Class Schedule Teacher Date : Lou Christine S. Gatoc Score: ____ : ___________________ : AE 212 & 412 – Economic Development : MWF (6:00 pm –7:00 pm)&(7:00 pm-8:00pm) : Bernadette B. Aves, MBA : April 1, 2020 (Wednesday) MODULE 5 Learning Activity Sheet # 5 Lesson / Topic : Part 1 – Money, Growth & Inflation Learning Target(s) : Reference(s) : The Principles of Economics, 7th edition by Gregory Mankiw https://www.youtube.com/watch?v=q59tZKP0HME https://www.youtube.com/watch?v=SP37en1KWiI Concept/ Digest : To read and understand clearly the Quantity Theory of Money To watch the youtube videos about the explanation of the topic To answer questions related to the topic We often hear our parents and grandparents or older people telling us that during their time, they could go to the market and buy a basket full of food at P20.00. But today, we tend to copy the famous line in the advertisement – “saan aabot ang 20 pesos mo?” Indeed, prices of commodities are continuously rising, especially during this difficult time that Some people are taking advantage of the ever increasing need of face masks, gloves, alcohol, hand sanitizer, among others. This increase in the prices of commodities is what we refer to in economics as inflation. This is just a norm in most of the economies in the world. However, the level of inflation varies and if it is too high already, it would cause a major economic problem. In this lesson, we will find out what determines inflation and how much is the level of inflation. This brings us to the study of the Quantity Theory of Money. One of the Principles of Economics states that: Prices rise when the government prints too much money. We begin the lesson about inflation by developing the quantity theory of money. This theory is often called “classical” because it was developed by some of the earliest economic thinkers. Most economists today rely on this theory to explain the long-run determinants of the price level and the inflation rate. The first insight about inflation is that it is more about the value of money than about the value of goods. The economy’s overall price level can be viewed in two ways. In one of the topics that we discussed in the past, we viewed the price level as the price of a basket of goods and services. When the price level rises, people have to pay more for the goods and services they buy. Alternatively, we can view the price level as a measure of the value of money. A rise in the price level means a lower value of money because each peso in your wallet now buys a smaller quantity of goods and services. What determines the value of money? The answer to this question, like many in economics, is supply and demand. Thus, our next step in developing the quantity theory of money is to consider the determinants of money supply and money demand. This is the Money Supply in the Philippines: M1 or Narrow Money – consists of currency in circulation (or currency outside depository corporations) and peso demand deposits. M2 or Broad Money – consists of M1 plus peso savings and time deposits. M3 or Broad Money Liabilities – consists of M2 plus peso deposit substitutes, such as promissory notes and commercial papers (i.e., securities other than shares included in broad money). M4 - consists of M3 plus transferable and other deposits in foreign currency. With regards to the quantity of money demanded, there are many factors that influence the quantity of money demanded. The amount of currency that people hold in their wallets, for instance, depends on how much they rely on credit cards and on whether an automatic teller machine is easy to find. The quantity of money demanded depends on the interest rate that a person could earn by using the money to buy an interest-bearing bond rather than leaving it in a wallet or low-interest checking account. Although many variables affect the demand for money, one variable stands out in importance: the average level of prices in the economy. People hold money because it is the medium of exchange. Unlike other assets, such as bonds or stocks, people can use money to buy the goods and services on their shopping lists. How much money they choose to hold for this purpose depends on the prices of those goods and services. The higher the prices are, the more money the typical transaction requires, and the more money people will choose to hold in their wallets and checking accounts. That is, a higher price level (a lower value of money) increases the quantity of money demanded. In the long run, money supply and money demand are brought into equilibrium by the overall level of prices. If the price level is above the equilibrium level, people will want to hold more money than the BSP has created, so the price level must fall to balance supply and demand. If the price level is below the equilibrium level, people will want to hold less money than the BSP has created, and the price level must rise to balance supply and demand. At the equilibrium price level, the quantity of money that people want to hold exactly balances the quantity of money supplied by the BSP. Examples : Suppose P is the price level as measured, for instance, by the CPI or the GDP deflator. Then P measures the number of pesos needed to buy a basket of goods and services. Now turn this idea around: The quantity of goods and services that can be bought with P1 equals 1/P. In other words, if P is the price of goods and services measured in terms of money, 1/P is the value of money measured in terms of goods and services. This mathematics is simplest to understand in an economy that produces only a single good, say, ice-cream cones. In that case, P would be the price of a cone. When the price of a cone (P) is P20, then the value of a peso (1/P) is half a cone. When the price (P) rises to P30, the value of a dollar (1/P) falls to a third of a cone. The actual economy produces thousands of goods and services, so we use a price index rather than the price of a single good. But the logic remains the same: When the overall price level rises, the value of money falls. Refer to Figure 1 on How the Supply and Demand for Money Determine the Equilibrium Price Level Exercises / Questions: INSTRUCTIONS: 01. Read and understand pages 633-637 of the pdf of the textbook. Watch also the youtube videos specified above so that you could understand better the topic for this module. 02. Answer the following questions and submit it thru messenger not later than 5 pm today, April 1, 2020. a. Explain how an increase in the price level affects the real value of money. An increase in the price level reduces the real value of money because each dollar in your wallet now buys a smaller quantity of goods and services. b. According to the quantity theory of money, what is the effect of an increase in the quantity of money? According to the quantity theory of money, an increase in the quantity of money causes a proportional increase in the price level. c. Wages and prices are many times higher today than they were 30 years ago, yet people do not work a lot more hours or buy fewer goods. How can this be? Inflation has raised the general price level. An increase in the general price level has no effect on real variables in the long run. Wages are higher, but so are prices. Prices are higher, but so are wages and incomes. In the long run, people change their behavior in response to changes in real variables, not nominal ones. d. Define each of the symbols and explain the meaning of M V=P Y. M is the money supply/ all the money in the economy. V is how many times the money is spent purchasing goods and services. Example is when hoarding, their money has low velocity. When spending or investing the money quickly, it has a high velocity. V is the number of times the average money is spent. P would be the price of all finished goods and services in an economy. Y would be all the finished goods and services sold in an economy, which stands for real GDP. When you multiply P and Y, you would get the nominal GDP. Also, when you multiply M and V, you would also get the nominal GDP, which makes the equation true that MxV=PxY. M x V covers all the actions of BUYERS, while P x Y covers all the actions of SELLERS. e. Research about the inflation rate of the countries assigned to your group in Assignment #3. Give also the factors that contribute to such inflation rate. The annual inflation rate in Mexico increased to 3.70 percent in February 2020 from 3.24 percent in the previous month and above market expectations of 3.56 percent. In Mexico, the most important categories are Nonfood Goods (19.7 percent of the total weight); Housing (18.7 percent) and Other Services (18.4 percent). Food, Beverages and Tobacco account for 14.8 percent and Energy for 9.5 percent. Others include: Products subsidized by the government (5.3 percent); Education (5.1 percent); Meat and Eggs (4.8 percent) and Fruits and Vegetables (3.7 percent).
