EC233 Lecture Notes - Lecture 16: Bank Reserves, Budget Constraint, Monetary Base

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turquoisewasp140

6 Dec 2020

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Velocity of money and the equation of exchange. Y = aggregate output (incom e) p y=aggregate nominalincome (nominalgdp) V = velocity of m oney (average num ber of tim es per year that a dollar is spent) Demand for money: to interpret a simple version of irving fisher"s quantity theory in terms of the demand for money: divide both sides by v. 1 p y k = When the money market is in equilibrium, m = md. In the simplest version of the theory, velocity is fairly constant in the short run. This assumption transforms the equation of exchange into the quantity theory of money, which states that nominal income (spending) is determined solely by movements in the quantity of money m. p y=m v . M v y : - percentage change in (x y) = (percentage change in x) + (percentage change in y) follows:

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

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?

fuchsiamallard938

A) Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = $1.0. The aggregate demand curve is Y = 2(M/P) and M = 1,500.

i) If the economy is initially in long-run equilibrium, what are the values of P and Y?

ii) What is the velocity of money in this economy?

iii) If M increases to 2,000, what are the new short-run values of P and Y?

iv) Once the economy adjusts to long-run equilibrium at M = 2,000, what are P and Y?

B) Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = $1.0. The aggregate demand curve is Y = 3(M/P) and M = 1,000.

i) Suppose a supply shock moves the short-run aggregate supply curve to P=$1.5. What are the new short-run P and Y? What will be the new long-run P and Y?

ii) Suppose that immediately after the supply shock the Federal Reserve Bank wanted to hold output at its long-run level. What level of M would be required? If this level of M were maintained, what would be long-run equilibrium P and Y?

C) Use the aggregate demand/aggregate supply model to illustrate graphically the impact in the short run and the long run of the following changes. (Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-run equilibrium values). Also, state what happens to prices and output in the short run and the long run.

i) The Federal Reserve Bank engages in expansionary monetary policy.

ii) Climate change causes reduced food production.

iii) Labor unions are banned.

lavenderrat653

EC233 Lecture Notes - Lecture 16: Bank Reserves, Budget Constraint, Monetary Base

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