10. Economic Performance - Quantity Theory of Money Flashcards Preview

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Flashcards in 10. Economic Performance - Quantity Theory of Money Deck (6)
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1
Q

Who came up with the quantity theory of money and what is it?

A

Developed by Irving Fisher the quantity theory if money states; there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold (inflation).

2
Q

What is the formula for the quantity theory of money?

A

MV = PQ M = Money SupplyV = Velocity of CirculationP = Average Price LevelQ = Quantity of goods/services sold

3
Q

Why does MV = PQ?

A

By definition the 2 sides must balance bc;Money Supply x Velocity of Circulation = Total Expenditure in an economy (what’s bought)Average Price Level x Quantity of goods/services sold = total output (what’s sold)Whats bought must have been sold by somebody and whats sold must have been bought - therefore the 2 have to be equal

4
Q

How does the equation show the factors affecting inflation?

A

If you reword the same equation you get P = MV/QAverage Price levels (inflation) are dictated by the money supply, velocity of circulation and quantity of goods and services sold.

5
Q

How would a monetarist claim inflation is directly determined by the money supply alone?

A

A monetarist would say that V is broadly fixed with only marginal variations in booms and recessions and data suggest Q is also fixed. If you remove these from the equation you end up with M = P.

6
Q

How would a Keynsian economist challenge this view?

A

They’d argue that V is actually highly variable - e.g. in the credit crunch, banks stopped lending bc of the liquiduty trap so V fell dramatically

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