ECON 102 Chapter Notes - Chapter 19: Opportunity Cost, E-Commerce Payment System, Hyperinflation

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Chapter 19 notes: quantity theory, inflation, and the demand for money. Monetary theory - the study of the effects of money and how monetary policy affects the economy. How the nominal value of aggregate income is determined. It suggests that interest rates have no effect on the demand of money. Velocity of money - the average number of times per year (turnover) that a dollar is spent in buying the total amount of goods and services produced in the economy. Relationship between m (the money supply) and p*y (aggregate national income) Equation of exchange - identity - nominal income in relation to the quantity of money and velocity. M x v = p x y. The quantity of money multiplied by the number of times this money is spent in a given year must equal nominal income. When the money supply m changes, nominal income changes in the same direction.

Related Questions

There are many economic models to explain the macro-economies function. Adam Smith started the classic economic thinking with his laissez-faire theory. The classical foundation for the role of money supply in an economy started in the mid-1700s. In classic macroeconomics, money is used for transactions. If there is more money or less money in circulation then it means that the prices are higher or lower. The classic model dominated microeconomics and macroeconomics of 1800 and 1900. In the classic macroeconomic model, the role of money is that it is used for transactions. The classic role of money can be understood through the quantity theory of money. The quantity theory of money states that if there are changes in the price level, then there will be corresponding changes in the money supply. The equation for the quantity theory of money is: M * V = P * Q

In this equation,

M = Nominal money supply

V = Velocity of money

P = Average price level

Q = Quantity of goods and services sold

The average price times quantity of goods and services sold represents the nominal GDP. The velocity of money is the number of times a currency is spent during a year.

Say's Law states that supply creates its own demand. It means that the income that is derived from producing some goods by an individual, allows him to purchase goods produced by some other individual. Since everyone has a need to purchase goods, they will produce some goods to earn income and buy what they want. So, the product markets will always be in equilibrium.

Show an empirical study that tests the relative inflation and growth rates on the nominal exchange rates.

copperlouse565

1. According to the principle of monetary neutrality:

a. Changes in the money supply do not affect real variables.

b. Real variables do not affect nominal variables.

c. Nominal variables are not adjusted for inflation and real units are adjusted for inflation.

d. Nominal variables are expressed in monetary units and real variables are expressed in physical units.

2. The velocity of money is:

a. The speed at which the money multiplier works.

b. The speed at which prices rise in the economy.

c. The time it takes for checks to be cleared by the Fed.

d. The rate at which money changes hands.

3. If the Fed increased the supply of money, and velocity remains unchanged, according to the quantity equation:

a. P x Y must decrease.

b. Y must decrease.

c. P x Y must increase.

d. Y must increase.

4. When inflation turns out to be higher than expected, borrowers will be ________ off, and lenders will be ________ off.

a. Better, better

b. Better, worse

c. Worse, worse

d. Worse, better

5. Suppose the value of goods and services produced in an economy is $10 billion, but the total money supply is $1 billion, what is the velocity of money?

a. 0

b. 1

c.5

d. 10

6. The quantity theory of money states that:

a. All else equal an increase in money growth will lead to a proportionate increase in prices in the long-run.

b. All else equal an increase in money growth will lead to a proportionate increase in prices in the short-run.

c. An increase in money growth can lead to inflation if and only if velocity is constant.

d. An increase in money growth must lead to a decrease in velocity.

7. In a country with hyperinflation, the value of money

a. Is increasing over time.

b. Is decreasing quickly over time.

c. Is remaining constant.

d. May either be increasing or decreasing.

Consider an economy where the production function is given by Y = K^(1/2)L^(1/2). The level of capital in the economy equals 400, and the number of employed workers is 225. Suppose the quantity of money in the economy equals 200, and the velocity of money circulation is constant and equals 5. Suppose initially the economy is in the long-run equilibrium.

1. Use the quantity theory of money to determine the aggregate demand in the economy.

2. Determine the equilibrium output and the price level in period 0.

3. Suppose in period 1 the central bank decreases money supply by 50. What will happen to output in the short-run?

4. Is monetary policy neutral in the short-run?

5. What will be the equilibrium price level and output after prices adjust to the shock?

6. Is monetary policy neutral in the long-run?

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ECON 102 Chapter Notes - Chapter 19: Opportunity Cost, E-Commerce Payment System, Hyperinflation

ECON 102 Full Course Notes

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