Download Section 55 - Carsonville Port Sanilac

The Quantity Theory of Money
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Money is defined as anything that is commonly used as a medium of
exchange.
The quantity of money available determines the price level, and the
growth rate of the quantity of money determines the inflation rate.
The velocity of money determines on average how many times a dollar is
spent in one year.
The quantity equation: money supply • velocity of money = price •
quantity.
If the velocity of money is held constant, any change in the money supply
must change one or both components of GDP—price and/or quantity.
The classical view of money states that changes in nominal variables will
only affect other nominal variables.
The quantity theory of money, as
shown on the left, determines the
effects on prices and output that result
from changes in the money supply,
holding the velocity of money
constant.
In the simple example on the left, the
money supply consists of $1. Because
the velocity of money is constant at 2,
the price of the one car produced must
equal $2.
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1205.doc –rev 11/07/2006
Changing the money supply will affect
either output or price. In a recession,
unemployment is high. An increase in
the money supply will provoke an
increase in real GDP and economic
expansion. In an expanding economy,
unemployment is low, and an increase
in the money supply will only provoke
an increase in the price level and
recession.
The classical view of money holds the
velocity of money constant as well as
output in the long run. Thus, any
change in the money supply (a nominal
variable) will change the price level (a
nominal variable).
www.compasslearning.com
Copyright ã 2006, Thinkwell Corp. All Rights Reserved.
1205.doc –rev 11/07/2006