Exam: ECON 1000C
Date: Thursday, April 19 at 9:00am
Place: Field House, Rows 34-50
Covers: Macro Chapters 5-17
Study: Textbook, Assignments, Past Exams and Study Guide
Pass Mock Exam: Tues April 17 6-8pm, Wed April 18: 12-2pm (AP 132) Email:

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Review Chapters 5-17 Part 2
Money Prices and Inflation Continued
The Velocity of Money Equation
• What is the velocity of money?
o The rate at which money changes hands / the number of transactions in which
the average dollar is used
o The Velocity Formula: V = (P x Y) / M
• V = velocity of money
• P x Y = nominal GDP = price level x real GDP
• M = money supply
The Quantity Equation
• Is a restatement of the velocity equation
• Quantity equation: M x V = P x Y
o V is constant/stable
o
Y is unaffected by money developments (money supply) as it is a real variable
o If money supply (M) is doubed, nominal GDP (P x Y) doubles, since real GDP (Y)
unaffected by monetary developments, then price (P) doubles
Foreign Sector and the Open Economy
Exchange Rates
• Nominal exchange rate:
o The rate at which a person can trade the currency of one country for the currency
of another
• Real exchange rate:
o The rate at which the goods and services of one country trade for the goods and
services of another
o Real exchange rate: (e x P)/(P*)
• E = nominal exchange rate
• P = domestic price
• P* = the foreign price (in foreign currency) of same good or goods
• Basically, e x P is the price of the good in Canada stated in a foreign
currency
Purchasing Power Parity
• Purchasing Power Partity:
o Theory explaining the variation of currency exchange rates ( e )
o Theory based on principle called the law of one price: a good must sell for the
same price in all locations
o PPP implies that nominal exchange rates ( e ) adjust to equalize the price of a
basket of goods across countries o Real exchange rate = (e x P)/P* = 1
• E adjusts so price is the same in both markets
• If e x P = P*, then real exchange rate = 1
Implications of Purchasing Power Parity (PPP)
•What would tend to happen if (e x P)/P* < 1 ?
o E is less than predicted by PPP, and therefore e would tend to rise in order to
being the exchange rate equal to one. This means that the Canadian dollar was
undervalued
•What would tend to happen if (e x P)/P* > 1 ?
o That means that the price in Canada exceeds the price abroad, and therefore the
dollar is overvalued. E is more than predicted by PPP and therefore will fall.
Saving and Investment in an O