ASSIGNMENT#3 The Economy In The Long Run Money and Inflation Submission Date:March 4,2013 Student ID: 14875

Faculty: Ms.Nazia Azfar

Q1(a).What is Fiat money?

Fiat money is a type of money which has no intrinsic value.It is a norm in most of the economies.

Q1(b).What is Commodity money?

Commodity money is money whose value comes from a commodity of which it is made. Commodity money consists of objects that have value in themselves as well as value in their use as money,i.e; they have intrinsic value.

Q2.How is the quantity of money measured?

Money is the stock of assets used for transactions,the quantity of money is the quantity of those assets.One of the common asset to include in the quantity of money is the currency,the sum of outstanding paper money and coins.Most day-to-day transactions use currency as the medium of exchange.A second type of asset used for transactions is demand deposits,the funds people hold are their checking accounts.In both cases the assets are in form are in a form to readily facilitate a transaction.

Q3.Write the quantity equation and explain it.

The quantity equation is an identity: the definitions of the four make it.If one variable changes,one or more of the others much also change to maintain the identity.The quantity equation we will

use from now on is money supply (M) times the velocity of money (V) which equals price (P) times the number of transactions (T): MxV=PxT V in the quantity equation is called the transactions velocity of money. Transactions and output are related,because the more the economy produces,the more goods are bought and sold. If Y denotes the amount of output and P denotes the price of one unit of output,then the dollar value of output is PY .We encountered measures for these variables when we discussed the national income accounts. Money x Velocity=Price x Output MxV=PxY This version of the quantity equation is called the income velocity of money.

Q4.List all the costs of inflation you can think of and rank them according to how important you think they are.
Low inflation is the main macro economic goal for most western countries because there are very many economic costs of high inflation.

* Cost of reducing inflation: High inflation is deemed unacceptable so governments feel it's best to reduce it. This will involve higher interest rates. The following reduction in aggregate demand will lead to a decline in economic growth and unemployment. * International competitiveness: Higher prices will make home-produced goods less competitive, leading to a fall in exports. However this may be offset by a decline in the exchange rate (if applicable). * Confusion and Uncertainty: When inflation is high people become more uncertain what to spend their money on. Also when inflation is high firms may be less willing to invest because they are uncertain about future profits. * Menu Costs. The cost of changing price lists can be a problem - especially if hyperinflation is prevalent. *Income redistribution. Borrowers will become better off, while lenders will become worse off, however this depends on the real rate of interest. *Boom and bust economic cycles. High inflationary growth is unsustainable and is usually followed by a recession. By keeping inflation low it enables a long period of

economic growth. This is one of the most important reasons * Fiscal Drag. The amount of tax we pay will increase if there is inflation.