ECON 272

Out of Class Practice Problem on the Process of Inflation

1.  Assume there is an increase in the money supply.  At the same time there is also an increase in money demand due to an increase in AS or the size of the pie - but this increase is not as large as the increase in the money supply.  Assume velocity is constant.

Explain (the steps) what will happen to prices and the purchasing power of money because of these changes.

2.  Assume there is a decrease in the money supply.  At the same time assume that velocity, AS, and money demand are constant.

Explain (the steps) what will happen to prices and the purchasing power of money because of these changes.

3.  Explain injection (or Cantillon) effects and why money (inflation) is NOT neutral - what happens in the economy besides simply price increases due to injection effects?  In your explanation - discuss why some people gain in this process while others lose.