Question

A. Give the equation of exchange.  For each variable in the equation, explain or define it briefly.

B. Since 2007 (quant. easing), many non-Keynesian economists (Classical) have been predicting a rapid increase in the inflation rate.  Why?  Use the equation in your answer.

C. Why do Keynesian economists believe increasing the money supply is a good idea?  Use the equation in your answer.

D.  Use the equation to explain or illustrate “Friedman’s Rule.”

E. John Taylor had an opinion about one of the variables in the equation.  Identify the variable.  What was his solution?

F. Use the equation to explain or illustrate the difference between regular inflation and hyper-inflation.

Answer 1

a)

Equation of Exchange:-

Equation of exchange represents a mathematical equation that shows the relatonship between the 4 variables. The four variables are :- money supply, velocity of money supply, average price level and index of expenditure.

The equation is stated as:-

  M*V = P*T

Where,

• M represents the sum of all the money supply which is circulated in the economy .
• V reprents the velocity of money supply which means the average number of times that certain currency units have chnaged hands per year.
• P refers to the price level of goods during the year
• T represents the index of real value of the aggregate transactions.

According to the  Equation of exchange, it is clerified that the total amount of money which changes hands in market or economy is equal to the total money value of the goods in the market or economy.