Classical Macroeconomics2

Classical Macroeconomics2 - Classical Macroeconomic Money,...

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Classical Macroeconomic Money, Prices, Interest
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Quantity Theory of Money Velocity of Money – rate at which money turns over in GDP transactions during a given period of time Quantity Theory – the classical theory that states that the price level is proportional to the quantity of money in circulation
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Equation of Exchange Equation of Exchange – MV T =P T T Developed by Irving Fisher M = quantity of money V = velocity of money P = price level T = volume of transactions
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Equation of Exchange and GDP If all transactions are for current production then the equation of exchange can be written MV = PY where Y=GDP V is determined by institutional factors and does not change in the short run and Y is fixed by production conditions In this case, the price level is determined by the quantity of money
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The Cambridge Approach Cambridge Approach – a version of the quantity theory that focuses on the demand for money Developed by Alfred Marshall and A.C. Pigou M d =kPY M d =money demand k=proportion of income held as money
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Money and Prices The Cambridge Explanation Starting in equilibrium (money demand equals money supply), suppose the stock of money increases The increase in the quantity of money creates an excess supply of money Individuals react by increasing consumption and investment spending Demand for commodities increases but since supply is fixed, this drives up prices
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Classical Macroeconomics2 - Classical Macroeconomic Money,...

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