James Murray

These pencast lectures and problems are based on Chapter 10 of your textbook. This chapter brings together the Dynamic General Equilibrium model of the last chapter (Market for Labor, Market for Final Goods and Services, and the Demand for Consumption and Investment. First read Chapter 10, then watch the pencasts below. After this, do the exercise at the bottom of the page as a homework assignment due at the beginning of class on Tuesday, November 29.

This first pencasts describes what is the demand for money, and what influences it. It describes where the money demand function comes from, but without many of the complicated mathematical details necessary to derive it. From this pencast, you should understand how to draw the money demand function, and how real GDP, the real interest rate, and the inflation rate affect the money demand decision.

This next pencast illustrates equilibrium in the money market. It combines the demand for money derived in the previous pencast, with the supply of money as determined by the Federal Reserve, the central bank for the United States. This pencast illustrates the effect an increase in money supply has on the price level. The pencast illustrates a concept called, Neutrality of Money, which concludes that a change in money supply will only affect the aggregate price level in the economy, but no real variables. The neutrality of money therefore implies monetary policy has no affect on real wages, employment, or production. This may be a realistic long-run conclusion, but there is strong evidence this is not true in the short-run. The next chapter will further extend this model to illustrate how monetary policy can have real effects in the short run, which can be used to combat a recession.

This pencast illustrates what happens in the money market if there were to be an increase in financial transaction costs. The increase in these transaction costs makes it more costly to purchase "credit" goods, which are goods for which cash-in-advance is not required. A short summary is that as the demand for credit goods falls, the demand for cash goods rises (a substitute), causing an increase in money demand.

This final pencast brings the Money Market into the General Equilibrium framework of the last chapter. This pencast considers what happens when there is an improvement in technology. Many of the results for the last chapter are described again, including the effect on the labor market, the market for final goods and services, and the demand for consumption and investment. The results on the real interest rate and the real GDP illustrated in the market for final goods and serices are then taken to the market for money to determine the effect on money demand and the aggregate price level.

Use what you have learned to answer the questions in the homework assignment below. This assignment involves some questions similar to the in-class exercise on dynamic general equilibrium models, but now the model includes the market for money, and therefore it can be used to determine the effect on the aggregate price level in the economy.

Homework Assignment on the Monetary Dynamic General Equilibrium Model, due in class on Tuesday, November 29, 2011.