Essay --

Economic Principles Some of the most heated debates in macroeconomics in recent years have been concerned with the causes and consequences of inflation, the relationship between inflation and unemployment, and appropriate policy responses. Inflation and Unemployment in the AS-AD Model Inflation may be defined, for our purposes, as the proportionate increase in the price level per period of time. Another way of looking at inflation would be to point out that as the price level rises the real value of a given nominal amount of money falls, so that is to say that as the price level rises $1 will buy fewer and fewer goods. Thus, inflation might, alternatively, be defined as the proportionate decline in the purchasing power of a given nominal amount of money. In this sense, inflation is a monetary phenomenon. Therefore, Laidler and Parkin argue that its importance ‘stems from the pervasive role played by money in a modern economy’. Friedman goes further than this and argue s that inflation ‘is always and everywhere a monetary phenomenon †¦ and can be produced only by a more rapid increase in the quantity of money than in output. He clearly has views not only on what inflation is, but also on what causes it. By no means all economists agree with Friedman on the causes of inflation, and it is such issues, which are the focus of much of this chapter. There is also much disagreement about the consequences of inflation. Most would agree that a short bout of inflation, or a persistent but well-predicted one, would not be as harmful as a persistent and unpredictable bout of inflation. Even for the latter case there are those who argue that the consequences are not that serious, while others argue that unpredictable inflation distorts the mec... ...lated by discounting the income, but to the permanent magnitudes. To take the extreme case as illustration: Wn is wealth possessed by an individual during his whole life’; and Yn is the average (permanent) lifetime income. This novel definition of terms is closely connected to Friedman’s research on the consumption function4, and it is very significant to his theory. Friedman applies his concept of permanent income to the theory of money demand, too. Permanent income is the return on a rather widely defined stock of nominal wealth. The latter consists of Money: a means of payment with a constant face value that does not yield interest; Bonds: interest bearing securities with a constant face value; Equalities: claims on the profits of a firm; Physical goods; and Human capital. Hence, Ln = f (P, rB, rE, P/ P, Yn p/r) (+) (-) (-) (-) (+)