Today comes news that oil prices are approaching $40/Bl and the US lost a half million jobs last month. This kind of negative news pushes the demand for energy down as people without work cut back on spending since they have no money coming in, which means supply is greater than demand. The price individuals are willing to pay for a good is below the market equilibrium at the previous price, so the result is underconsumption. If people are homeless long enough, the income change will cause the whole demand curve to shift down, which lowers the price for the good supplied.
In other words, people without the money for gas to drive will not drive. The only good news from this economic downturn is that many a petrodictator is going to be dropping a brick if prices get much lower. Their lavish spending while the population starves will catch up quickly.
Showing posts with label Money supply. Show all posts
Showing posts with label Money supply. Show all posts
Friday, December 5, 2008
Sunday, May 4, 2008
First post in ages
While I have been bogged down in economics finals, I decided to post something to break the silence. Today's lesson is the relationship between money supply and output, a concept which was not understood before the 60's and Milton Friedman.
In short, the relationship is governed by a balanced equation where the change in money supply time the velocity(how fast money circulates in an economy) is equal to the change in output time the change in prices. In other words MS*V=Q*P. Thus if the money supply rises, either price or output, or both must rise to match the increase. The effect of this relationship is that inflation and deflation are better understood as products of MS, rather than being arbitrary. Also, if money loses enough value that it ceases to be circulated much, then serious deflation occurs, as happened during the early days of American Banking. The goal of an economy should be to balance these forces out to keep output rising without increasing inflation outside of comfortable levers(circa 3%). For much of the 90's we were in such a pattern, but the collapse of the housing market and the lowering of interest rates to 2% increased prices and a slight amount of output, but since P was greater than Q, real inflation occurred.
In short, the relationship is governed by a balanced equation where the change in money supply time the velocity(how fast money circulates in an economy) is equal to the change in output time the change in prices. In other words MS*V=Q*P. Thus if the money supply rises, either price or output, or both must rise to match the increase. The effect of this relationship is that inflation and deflation are better understood as products of MS, rather than being arbitrary. Also, if money loses enough value that it ceases to be circulated much, then serious deflation occurs, as happened during the early days of American Banking. The goal of an economy should be to balance these forces out to keep output rising without increasing inflation outside of comfortable levers(circa 3%). For much of the 90's we were in such a pattern, but the collapse of the housing market and the lowering of interest rates to 2% increased prices and a slight amount of output, but since P was greater than Q, real inflation occurred.
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