Need a math help for the Cagan's model in macroeconomics












2












$begingroup$


From the appendix after the chapter 4 in Macroeconomics 7th edition by Gregory Mankiw.




To keep the math as simple as possible, we posit a money demand function that is linear in the natural logarithms of all the variables. The money demand function is



$m_t − p_t = −gamma( p_{t+1} − p_t)$,



where $m_t$ is the log of the quantity of money at time t, $p_t$ is the log of the price level at time t, and $gamma$ is a parameter that governs the sensitivity of money demand to the rate of inflation. By the property of logarithms, $m_t − p_t$ is the log of real money balances, and $p_{t+1} − p_t$ is the inflation rate between period t and period t+1. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.





  1. Shouldn't $(p_{t+1} - p_t)$ be the log of inflation rate? Why it says just "the inflation rate"?




  2. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.




    My math level is like that of a high school. Would anyone be so nice and explain this for me? To me, it doesn't make sense at all.



    $ln frac{M}{P} = ln (frac{p_{t+1}}{p_t})^{-gamma} rightarrow frac{M}{P} = (frac{p_{t+1}}{p_t})^{-gamma}$



    So, if the $(p_{t+1} - p_t)$ is just the log of inflation rate, then $frac{p_{t+1}}{p_t}$ is the inflation rate and,




    inflation goes up by 1 percentage point




    would mean $frac{p_{t+1}}{p_t}$ is going to get +1, right? But I couldn't possibly think it would result the fall of $frac{M}{P}$ by the $gamma$ point. What am I missing?



    And secondly, if the $(p_{t+1} - p_t)$ is just the inflation rate,(not the log of any) then it bugs me more than the former. So, +1 change to the inflation rate is like nothing but that we would get "$−gamma(1 + p_{t+1} − p_t)$" at the right side, right? How could this be the case?












share|improve this question











$endgroup$

















    2












    $begingroup$


    From the appendix after the chapter 4 in Macroeconomics 7th edition by Gregory Mankiw.




    To keep the math as simple as possible, we posit a money demand function that is linear in the natural logarithms of all the variables. The money demand function is



    $m_t − p_t = −gamma( p_{t+1} − p_t)$,



    where $m_t$ is the log of the quantity of money at time t, $p_t$ is the log of the price level at time t, and $gamma$ is a parameter that governs the sensitivity of money demand to the rate of inflation. By the property of logarithms, $m_t − p_t$ is the log of real money balances, and $p_{t+1} − p_t$ is the inflation rate between period t and period t+1. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.





    1. Shouldn't $(p_{t+1} - p_t)$ be the log of inflation rate? Why it says just "the inflation rate"?




    2. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.




      My math level is like that of a high school. Would anyone be so nice and explain this for me? To me, it doesn't make sense at all.



      $ln frac{M}{P} = ln (frac{p_{t+1}}{p_t})^{-gamma} rightarrow frac{M}{P} = (frac{p_{t+1}}{p_t})^{-gamma}$



      So, if the $(p_{t+1} - p_t)$ is just the log of inflation rate, then $frac{p_{t+1}}{p_t}$ is the inflation rate and,




      inflation goes up by 1 percentage point




      would mean $frac{p_{t+1}}{p_t}$ is going to get +1, right? But I couldn't possibly think it would result the fall of $frac{M}{P}$ by the $gamma$ point. What am I missing?



      And secondly, if the $(p_{t+1} - p_t)$ is just the inflation rate,(not the log of any) then it bugs me more than the former. So, +1 change to the inflation rate is like nothing but that we would get "$−gamma(1 + p_{t+1} − p_t)$" at the right side, right? How could this be the case?












    share|improve this question











    $endgroup$















      2












      2








      2





      $begingroup$


      From the appendix after the chapter 4 in Macroeconomics 7th edition by Gregory Mankiw.




      To keep the math as simple as possible, we posit a money demand function that is linear in the natural logarithms of all the variables. The money demand function is



      $m_t − p_t = −gamma( p_{t+1} − p_t)$,



      where $m_t$ is the log of the quantity of money at time t, $p_t$ is the log of the price level at time t, and $gamma$ is a parameter that governs the sensitivity of money demand to the rate of inflation. By the property of logarithms, $m_t − p_t$ is the log of real money balances, and $p_{t+1} − p_t$ is the inflation rate between period t and period t+1. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.





      1. Shouldn't $(p_{t+1} - p_t)$ be the log of inflation rate? Why it says just "the inflation rate"?




      2. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.




        My math level is like that of a high school. Would anyone be so nice and explain this for me? To me, it doesn't make sense at all.



        $ln frac{M}{P} = ln (frac{p_{t+1}}{p_t})^{-gamma} rightarrow frac{M}{P} = (frac{p_{t+1}}{p_t})^{-gamma}$



        So, if the $(p_{t+1} - p_t)$ is just the log of inflation rate, then $frac{p_{t+1}}{p_t}$ is the inflation rate and,




        inflation goes up by 1 percentage point




        would mean $frac{p_{t+1}}{p_t}$ is going to get +1, right? But I couldn't possibly think it would result the fall of $frac{M}{P}$ by the $gamma$ point. What am I missing?



        And secondly, if the $(p_{t+1} - p_t)$ is just the inflation rate,(not the log of any) then it bugs me more than the former. So, +1 change to the inflation rate is like nothing but that we would get "$−gamma(1 + p_{t+1} − p_t)$" at the right side, right? How could this be the case?












      share|improve this question











      $endgroup$




      From the appendix after the chapter 4 in Macroeconomics 7th edition by Gregory Mankiw.




      To keep the math as simple as possible, we posit a money demand function that is linear in the natural logarithms of all the variables. The money demand function is



      $m_t − p_t = −gamma( p_{t+1} − p_t)$,



      where $m_t$ is the log of the quantity of money at time t, $p_t$ is the log of the price level at time t, and $gamma$ is a parameter that governs the sensitivity of money demand to the rate of inflation. By the property of logarithms, $m_t − p_t$ is the log of real money balances, and $p_{t+1} − p_t$ is the inflation rate between period t and period t+1. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.





      1. Shouldn't $(p_{t+1} - p_t)$ be the log of inflation rate? Why it says just "the inflation rate"?




      2. This equation states that if inflation goes up by 1 percentage point, real money balances fall by $gamma$ percent.




        My math level is like that of a high school. Would anyone be so nice and explain this for me? To me, it doesn't make sense at all.



        $ln frac{M}{P} = ln (frac{p_{t+1}}{p_t})^{-gamma} rightarrow frac{M}{P} = (frac{p_{t+1}}{p_t})^{-gamma}$



        So, if the $(p_{t+1} - p_t)$ is just the log of inflation rate, then $frac{p_{t+1}}{p_t}$ is the inflation rate and,




        inflation goes up by 1 percentage point




        would mean $frac{p_{t+1}}{p_t}$ is going to get +1, right? But I couldn't possibly think it would result the fall of $frac{M}{P}$ by the $gamma$ point. What am I missing?



        And secondly, if the $(p_{t+1} - p_t)$ is just the inflation rate,(not the log of any) then it bugs me more than the former. So, +1 change to the inflation rate is like nothing but that we would get "$−gamma(1 + p_{t+1} − p_t)$" at the right side, right? How could this be the case?









      mathematical-economics






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      edited Mar 24 at 10:19









      Giskard

      13.5k32248




      13.5k32248










      asked Mar 24 at 10:09









      dolcodolco

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      1304






















          1 Answer
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          $begingroup$

          The answer to both your questions is that for small $x$ values
          $$
          ln(1+x) approx x,
          $$

          the difference being less than $x^2/2$. (Proof by Taylor-approximation.)



          So if inflation is around 10%, then the absolute error from this type of approximation is less then 0.5%, which is pretty good.



          This should also answer your second question, as the approximation
          $$
          gamma x approx ln(1+ gamma x),
          $$

          works as well.



          It may also be worthwhile to look into elasticity.






          share|improve this answer









          $endgroup$














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            1 Answer
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            $begingroup$

            The answer to both your questions is that for small $x$ values
            $$
            ln(1+x) approx x,
            $$

            the difference being less than $x^2/2$. (Proof by Taylor-approximation.)



            So if inflation is around 10%, then the absolute error from this type of approximation is less then 0.5%, which is pretty good.



            This should also answer your second question, as the approximation
            $$
            gamma x approx ln(1+ gamma x),
            $$

            works as well.



            It may also be worthwhile to look into elasticity.






            share|improve this answer









            $endgroup$


















              3












              $begingroup$

              The answer to both your questions is that for small $x$ values
              $$
              ln(1+x) approx x,
              $$

              the difference being less than $x^2/2$. (Proof by Taylor-approximation.)



              So if inflation is around 10%, then the absolute error from this type of approximation is less then 0.5%, which is pretty good.



              This should also answer your second question, as the approximation
              $$
              gamma x approx ln(1+ gamma x),
              $$

              works as well.



              It may also be worthwhile to look into elasticity.






              share|improve this answer









              $endgroup$
















                3












                3








                3





                $begingroup$

                The answer to both your questions is that for small $x$ values
                $$
                ln(1+x) approx x,
                $$

                the difference being less than $x^2/2$. (Proof by Taylor-approximation.)



                So if inflation is around 10%, then the absolute error from this type of approximation is less then 0.5%, which is pretty good.



                This should also answer your second question, as the approximation
                $$
                gamma x approx ln(1+ gamma x),
                $$

                works as well.



                It may also be worthwhile to look into elasticity.






                share|improve this answer









                $endgroup$



                The answer to both your questions is that for small $x$ values
                $$
                ln(1+x) approx x,
                $$

                the difference being less than $x^2/2$. (Proof by Taylor-approximation.)



                So if inflation is around 10%, then the absolute error from this type of approximation is less then 0.5%, which is pretty good.



                This should also answer your second question, as the approximation
                $$
                gamma x approx ln(1+ gamma x),
                $$

                works as well.



                It may also be worthwhile to look into elasticity.







                share|improve this answer












                share|improve this answer



                share|improve this answer










                answered Mar 24 at 10:19









                GiskardGiskard

                13.5k32248




                13.5k32248






























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