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ECON 3430 Lecture Notes - Lecture 17: Liquidity Preference, Irving Fisher, Procyclical And Countercyclical

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mag0sea
14 Apr 2017
School
York University
Department
Economics
Course
ECON 3430
Professor
Brenda Spotton- Visano

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ECON 3430 Full Course Notes
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ECON 3430 Full Course Notes
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Document Summary

Quantity theory, inflation, and the demand for money. Chapter 20: velocity of money and the equation of exchange. Charge accounts and credit cards for transactions. If money supply equals money demand, then md = m. If velocity of money is constant, then let k = 1/v. Md = kpy: demand purely a function of income py, from the equation of exchange to the quantity theory of money, from the equation of exchange to the quantity theory of money. Provides a long-run theory because it is based on the assumption that wages and prices are flexible. Empirically, the growth rate of aggregate output over 10-year periods does not vary that much. Good explanation for cross-country inflation differences: the short run. Go into debt by issuing government bonds: the government can also create money and use it to pay for the goods and services it buys, the government budget constraint.

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Related Questions

4. Velocity and the quantity equation

Consider a simple economy that produces only cell phones. The following table contains information on the economy's money supply, the velocity of money, price level, and output. For example, in 2011, the money supply was $240, the price of a cell phone was $7.20, and the economy produced 500 cell phones.

Fill in the missing values in the following table, rounding to the nearest cent when necessary.

Year Quantity of Money Velocity of Money Price Level Quantity of Output Nominal GDP
(Dollars) (Dollars) (Cell phones) (Dollars)
2011 240   7.20 500 (66.00/3,780.00/69.00/3600.00)
2012 252 15 (0.53/0.50/7.56/7.20) 500 (3780/3600/66/69)

The money supply grew at a rate of (5%/105%/2.44%/1.44%) from 2011 to 2012. Since cell phone output did not change from 2011 to 2012 and the velocity of money (increased/decreased/remained the same), the change in the money supply was reflected (partially/entirely) in changes in the price level. The inflation rate from 2011 to 2012 was (5%/2.44%/1.44%/105).

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 Quantity Equation MV = PY can be expressed as follows: (Growth Rate in the Money Supply) + (Percentage Change in Velocity) = (Inflation Rate) + (Growth Rate of Real GDP).

Given this fact, suppose the money velocity falls by 50% because individuals and companies begin stockpiling money in safes and under their beds rather than spending it. Explain in terms of the Quantity Equation why this drop in velocity threatens to cause a big drop in economic well-being. Can you design a money supply policy for the Fed that might allow it to prevent a 50% drop in the real GDP? If so, explain why you think it is appropriate? Does your answer change if you believe the Classical Dichotomy always holds?