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are measured in monetary units.
Examples: nominal GDP, nominal interest rate (rate of return measured in $) nominal wage ($ per hour worked) |
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are measured in physical units.
Examples: real GDP, real interest rate (measured in output) real wage (measured in output) |
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the theoretical separation of nominal and real variables.all nominal variables—including prices—
will double.
all real variables—including relative prices—
will remain unchanged. |
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| the proposition that changes in the money supply do not affect real variables |
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the rate at which money changes hands
V =P x Y/M.....Nominal GDP/money supply |
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| M x V = P x Q....M x V/Q = P |
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| printing money causes inflation, which is like a tax on everyone who holds money. |
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| Nominal interest rate = inflation rate+real interest rate |
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| the resources wasted when inflation encourages people to reduce their money holdings |
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the costs of changing prices
Ex: Printing new menus, mailing new catalogs, etc |
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| Misallocation of resources from relative-price variability |
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| Firms don’t all raise prices at the same time, so relative prices can vary…which distorts the allocation of resources. |
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| Confusion & inconvenience |
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| Inflation changes the yardstick we use to measure transactions. Complicates long-range planning and the comparison of dollar amounts over time. |
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| Inflation makes nominal income grow faster than real income Inflation causes people to pay more taxes even when their real incomes don’t increase. |
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| Arbitrary redistributions of wealth |
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| Higher-than-expected inflation transfers purchasing power from creditors to debtors: Debtors get to repay their debt with dollars that aren’t worth as much. |
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