Lectures in Macroeconomics- Charles W. Upton Optimal Inflation 0 e R N r r
Lectures in Macroeconomics- Charles W. Upton Optimal Inflation.
Dec 22, 2015
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Lectures in Macroeconomics- Charles W. Upton
Optimal Inflation
0 eRN rr
Optimal Inflation
The Optimal Inflation Rate
• The private cost of holding money is rN• Economic Efficiency requires setting
PC=SC.
Optimal Inflation
The Optimal Inflation Rate
• The private cost of holding money is rN• Economic Efficiency requires setting
PC=SC.
SC = 0
Optimal Inflation
The Optimal Inflation Rate
0 eRN rr
Optimal Inflation
The Optimal Inflation Rate
0
0
Re
eRN
r
rr
Optimal Inflation
The Optimal Inflation Rate
0
0
R
e
Re
rY
Y
M
MY
Y
M
M
r
Optimal Inflation
The Optimal Inflation Rate
0
0
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Re
rY
Y
M
MY
Y
M
M
r
Optimal Inflation
The Optimal Inflation Rate
0
0
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e
Re
rY
Y
M
MY
Y
M
M
r
Optimal Inflation
Conclusion
• A 1% inflation rate costs $250 million
• Concentrate on price stability
Optimal Inflation
Uncertainty Costs
• Suppose next year's inflation rate is equally likely to be three, six, or nine percent.
3
1%)9(
3
1%)6(
3
1%)3(
P
P
P
Optimal Inflation
Production
• The CEO of Acme Widgets must price the product a year in advance.
3
1%)9(
3
1%)6(
3
1%)3(
P
P
P
Optimal Inflation
Production
• If the inflation rate turns out to be exactly six percent, the right price would be $1.00 each.
P$1
Optimal Inflation
Production
• If the inflation rate turns out to be 3%, he will have overpriced.
P$1
Optimal Inflation
Production
• If the inflation rate turns out to be 9%, he will have under priced.
P$1
Optimal Inflation
Production
• If the inflation rate turns out to be exactly six percent, the right price would be $1.00 each.
• If the inflation rate turns out to be nine percent, widgets would be priced 3% too low. He will sell more, but make less money.
• If the inflation rate turns out to be only three percent, widgets will be priced 3% too high and both demand and profits will suffer.
If the uncertainty can be ended, Acme can make more money.
At 3%, =$70
At 6%, = $100
At 9%, = $70
Optimal Inflation
Production
• If the inflation rate turns out to be exactly six percent, the right price would be $1.00 each.
• If the inflation rate turns out to be nine percent, widgets would be priced 3% too low. He will sell more, but make less money.
• If the inflation rate turns out to be only three percent, widgets will be priced 3% too high and both demand and profits will suffer.
At 3%, = $70
At 6%, = $100
At 9%, = $70
80$70$3
1100$
3
170$
3
1)( E
Optimal Inflation
Production
• If the inflation rate turns out to be exactly six percent, the right price would be $1.00 each.
• If the inflation rate turns out to be nine percent, widgets would be priced 3% too low. He will sell more, but make less money.
• If the inflation rate turns out to be only three percent, widgets will be priced 3% too high and both demand and profits will suffer.
If no uncertainty,
=$100
Optimal Inflation
Extra Uncertainty
At 0%, = $50
At 6%, = $100
At 12%, = $503
1%)12(
3
1%)6(
3
1%)0(
P
P
P
Suppose
Optimal Inflation
Extra Uncertainty
At 0%, = $50
At 6%, = $100
At 12%, = $503
1%)12(
3
1%)6(
3
1%)0(
P
P
P
Suppose
67$50$3
1100$
3
150$
3
1)( E
Optimal Inflation
Extra Uncertainty
At 0%, = $50
At 6%, = $100
At 12%, = $503
1%)12(
3
1%)6(
3
1%)0(
P
P
P
Suppose
Moral: the greater the uncertainty, the greater the chance you have made a mistake that costs you money.
Optimal Inflation
End
©2003 Charles W. Upton. All rights reserved
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