08 Equation of Exchange

08 Equation of Exchange - i 7 = 4 3 ii 10 = 4 6 iii 6 = 4 2...

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I. Equation of Exchange or Quantity Theory of Money a. MV (Total Spending)=PQ (Total Income) = Nominal GDP i. 1.3T x 11.2 = 14.5 T ii. M = Money Supply iii. V = Velocity of Money 1. How many times a year a dollar gets spent on average iv. P = Price Level b. Q = Quantity of Real Output (Real GDP) II. MV = PQ – Have to equal each other a. 10% = 10% b. 25% = 25% III. M + V = P + Q a. 3% + 0 = 0 + 3% i. P = Expected rate of inflation b. M + V = P + Q i. 10% + 0 = 7% + 3 c. Inflation – A rise in the general price level i. There is only one cause on inflation 1. The money supply increases faster than real output a. “Too much money chasing too few goods” d. M + V = P + Q i. 5 + 1 = 4 +2 e. M + V = P + Q i. 1 + 1 = -3 + 5 f. M + V = P + Q i. 4 + 1 = 3 +2 g. M + V = P + Q i. 6 + 2 = 3 + 5 IV. Fisher Equation a. Nominal Interest Rate = Real Rate of Interest + Inflation Rate

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Unformatted text preview: i. 7% = 4% + 3% ii. 10% = 4% + 6% iii. 6% = 4% + 2% iv. 22% = 19% + 3% b. ∆ M = 8% : 12 % : 5% c. ∆ V = 0% : 0 % : 0% d. ∆ Q = 3% : 3% : 3% e. Real Rate of Interest = 5% f. How Much is the nominal interest rate? i. Nominal Interest Rate = Real Rate of Interest + Inflation Rate 1. 10% = 5% + 5% 2. 14% = 5% + 9% 3. 7% = 5% + 2% ii. ∆ M + ∆ V = ∆ P + ∆ Q 1. 8% + 0% = 5 + 3% 2. 12 + 0 = 9 + 3 3. 5 + 0 = 2 + 3 iii. If the ∆ M is greater than the ∆ Q (with ∆ V=0) 1. Inflation rate will increase ( ∆ P) 2. Nominal interest rates increase 3. ⇑ MS nominal interest rates ⇑ iv. If you decrease ∆ M, then inflation rate decreases then 1. Nominal interest rates decrease 2. ⇓ MS nominal interest rates ⇓ See notes for graphs...
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