Question

Consider the equation of exchange (Quantity Theory of Money). Imagine that it is true that velocity is fixed. Show that money demand does not depend on interest rates. If this is true, draw a graph of Money Demand.

Answer #1

Velocity refers to measure of how often money “turns over” in a period; and is computed as nominal GDP divided by the nominal money supply. When quantity theory of money assumes that velocity is fixed, which indicates that real money demand is proportional to real income and is unaffected by the real interest rate, thus quantity equation turns to theory of the effects of money, called the quantity theory of money. Since velocity is constant, a change in the quantity of money (M) must cause a same change in nominal GDP (PY). Thus quantity of money determines the money value of the economy’s output.

Since demand for money does not depend on the interest rate, thus the LM curve is vertical (because the demand now will equal to money supply only at the specific level of income, Y for which that is true for all r).

What are the major assumptions of Quantity Theory of Money
Write down the Equation of Exchange in terms of
quantities.
Write down the Equation of Exchange in terms of rate of
change.
If the money supply is increased by 10%, and output did not
change, what is the increase in inflation according to the Quantity
Theory of Money under the assumption of constant velocity?

The equation of exchange ________. A) states that the quantity
of money multiplied by velocity must equal nominal income in a
given year B) describes a relationship that is true by definition
C) shows that real GDP must equal real money balances times the
number of times a dollar turns over in a year D) all of the above
E) none of the above

State the quantity theory of money. If the velocity of
circulation was not fixed in the long run, would the quantity
theory of money still hold ?

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?

According to the Quantity Theory of Money, a permanent increase
in money velocity will increase inflation permanently.
True or False
According to the Quantity Theory of Money, an unanticipated
money-based inflation stabilization program that permanently
reduces the money growth rate from 5 percent to 0 percent may cause
deflation in the period the program is announced.
True or False
According to the Solow Growth Model, poorer countries grow
faster.
True or False

Answer the following questions on the quantity theory of
money.
a) According to the quantity theory of money, what will happen
to nominal GDP if the money supply increases by 5% and the velocity
of money does not change?
b) What will happen to nominal GDP if, instead, the money supply
decreases by 8% and the velocity does not change?
c) What will happen to nominal GDP if, instead, the money supply
increases by 5% and the velocity decreases by...

Consider the short-run money market model and the short-run
exchange rate model together: a. Draw the combined models in a
single graph, showing the initial domestic interest rate (r1) and
the initial exchange rate (e1) b. Show how the short-run model
would change with a decrease in domestic money supply, specifically
noting the impact on domestic interest rates, exchange rates, and
the price level c. Following on from part (b), explain why the
exchange rate changes d. In the long-run,...

According to Irving Fisher equation, when velocity of money and
output are fixed, the monetary authority can control inflation rate
through controlling money supply(monetary policy) . What does the
quantity theory imply for the monetary policy in an economy with
unstable velocity? Explain factors that might make velocity of
money unstable and unpredictable?

1. Recall the classical economists and one of their
favorite theories: the quantity theory of money and monetary
neutrality. The theory is expressed as an equation as follows: M x
V = P x Y. What does V stand for?
a. the value of the domestic currency
b. the velocity of money
c. the virtual reality of the universe
d. the velocity of investment spending in the economy
2. Following up on question 1 above, what does Y represent?
a....

What is the quantity theory of money, and what does each term in
the equation represent?

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