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What is the equation of exchange (quantity theory of money)? How does it explain changes in...

What is the equation of exchange (quantity theory of money)? How does it explain changes in employment and the price level? Analyze figure 16-7 and explain what happens to inflation and employment as the Fed changes money supply.

What are the pros and cons of the Fed’s credit policy?

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Answer #2

Quantity Theory of Money (QTM) states that: (Money Supply, M)*(Velocity of money, V) = (Price, P)*(output, Y)

Employment and Y are directly related as can be seen from Okun's Law. Keeping M and V constant, We can see that as Employment rate increases, Y increases and to keep the equation in balance (since M and V are constant), P must decrease. Therefore, UNemployment decreases, price level also decreases and vice-versa. Employment and Price Level are inversely related. This is because as employment rises, output (or income) rises and thus, supply increases leading to a reduction in price level.

The figure referred to in the question is not uploaded so I cannot proceed further.

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