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ECON 1010 Lecture Notes - Lecture 8: Money Multiplier, Real Interest Rate, Reserve Requirement

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brownox746
13 Dec 2018
School
York University
Department
Economics
Course
ECON 1010
Professor
Shahed Khan

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Document Summary

As the real interest rate rises, expenditure plans are cut back and eventually the original full- employment equilibrium is restored. In the new long-run equilibrium, the price level has risen 10 percent but nothing real has changed. The quantity of money theory is the proposition that, in the long run, an increase in the quantity of money brings an equal percentage increase in the price level. It is based on the velocity of circulation and the equation of exchange. The velocity of circulation is the average number of times a year a dollar is used to purchase goods and services in gdp. V = velocity of circulation p = price level. Y = real gdp m = quantity of money. The equation of exchange becomes the quantity theory of money if m does not influence v or y. So in the long run, the change in p is proportional to the change in m.

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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.

The equation of exchange is an identity that relates the money supply, velocity, the price level, and real output.

Identity is something that is true by definition.

A. One group of economists, the monetarists, look at the equation of exchange and say that the Fed should simply increase the money supply by an annual rate equal to the long-run growth rate of the economy. Explain the effect that such a policy is likely to have on inflation. (5 points)

B. Another group of economists, those who hold to the quantity theory of money, believe that V is predictable and otherwise unchangeable and that Q is steady. Is their view of the economy consistent with the Keynesian view, the classical view, or neither? Explain. (5 points)

The equation of exchange is an identity that relates the money supply, velocity, the price level, and real output. Identity is true by definition.

One group of economists, the monetarists, look at the equation of exchange and say that the Fed should simply increase the money supply by an annual rate equal to the long-run growth rate of the economy. Explain the effect that such a policy is likely to have on inflation. (5 points)

Another group of economists, those who hold to the quantity theory of money, believe that V is predictable and otherwise unchangeable and that Q is steady. Is their view of the economy consistent with the Keynesian view, the classical view, or neither? Explain. (5 points)