Macroeconomics

‭Whereby:‬

‭●‬ ‭M‬‭is the money supply‬ ‭●‬ ‭V‬ ‭is‬ ‭the‬ ‭velocity‬ ‭of‬ ‭money‬ ‭which‬‭is‬‭the‬‭average‬‭number‬‭of‬‭times‬‭money‬‭changes‬‭hands‬‭and‬‭is‬ ‭assumed‬ ‭to‬ ‭be‬ ‭constant.‬ ‭For‬ ‭example,‬‭if‬‭V‬‭=‬‭3‬‭then‬‭every‬‭dollar‬‭in‬‭an‬‭economy‬‭gets‬‭used‬‭three‬ ‭times in a year.‬ ‭○‬ ‭M × V‬‭makes up the effective money supply‬ ‭●‬ ‭P‬‭is the price level‬ ‭●‬ ‭Y‬‭is the nominal or real GDP assumed to be at the‬‭full employment level.‬ ‭This‬ ‭equation‬ ‭basically‬ ‭states‬ ‭that‬ ‭all‬ ‭of‬ ‭the‬ ‭GDP‬ ‭that‬ ‭is‬ ‭bought‬ ‭(P‬ ‭×‬‭Y)‬‭is‬‭paid‬‭for‬‭using‬‭the‬‭effective‬ ‭amount‬‭of‬‭money‬‭available‬‭(M‬‭×‬‭V).‬ ‭Some‬‭economists‬‭deduce‬‭that‬‭when‬‭the‬‭velocity‬‭of‬‭money‬‭(V)‬‭is‬ ‭fxed,‬ ‭and‬‭real‬‭output‬‭is‬‭limited‬‭to‬‭full‬‭employment‬‭output‬‭(no‬‭output‬‭gap),‬‭any‬‭increase‬‭in‬‭money‬ ‭supply (M) causes an increase in the price level (P)‬ ‭.‬ ‭For‬ ‭instance,‬ ‭if‬ ‭V‬ ‭remains‬ ‭fxed‬ ‭at‬ ‭2,‬ ‭Y‬ ‭is‬ ‭at‬ ‭the‬ ‭full‬ ‭employment‬ ‭level‬ ‭of‬ ‭4,‬‭and‬‭M‬‭is‬‭6‬‭with‬‭P‬‭at‬‭3,‬‭the‬ ‭equation‬ ‭equates‬ ‭to:‬ ‭6‬ ‭×‬ ‭2‬ ‭=‬ ‭3‬ ‭×‬ ‭4‬ ‭ ⇒ ‬ ‭12.‬ ‭If‬ ‭M‬ ‭increases‬ ‭to‬ ‭10,‬ ‭P‬ ‭will‬ ‭rise‬ ‭to‬ ‭5‬ ‭in‬ ‭order‬ ‭to‬ ‭maintain‬ ‭equilibrium: 10 × 2 = 5 × 4 ⇒ 20.‬ ‭Consequently, the quantity theory of money has the following implications:‬ ‭1.‬ ‭When‬‭output‬‭(Y)‬‭is‬‭increasing‬‭while‬‭velocity‬‭(V)‬‭is‬‭constant,‬‭the‬‭money‬‭supply‬‭(M)‬‭must‬‭increase‬ ‭to prevent a decline in the price level (P).‬ ‭2.‬ ‭An‬‭increase‬‭in‬‭the‬‭money‬‭supply‬‭(M)‬‭without‬‭a‬‭corresponding‬‭increase‬‭in‬‭output‬‭(Y)‬‭causes‬ ‭the‬‭price‬‭level‬‭(P)‬‭to‬‭change‬‭by‬‭the‬‭same‬‭magnitude‬‭as‬‭the‬‭change‬‭in‬‭money‬‭supply‬ ‭.‬‭In‬‭other‬ ‭words,‬‭while‬‭output‬‭(Y)‬‭remains‬‭unchanged,‬‭when‬‭the‬‭money‬‭supply‬‭(M)‬‭doubles,‬‭the‬‭price‬‭level‬ ‭(P) also doubles.‬

‭Hence, the monetarist perspective that inflation is fundamentally a result of monetary factors.‬

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