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Chapter-9

# Chapter-9 - CHAPTER 9 Money the Price Level and Interest...

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CHAPTER 9 Money, the Price Level, and Interest Rates This chapter studies how changes in the money supply affect the supply of loans, Real GDP, the price level, the expected inflation rate, and the interest rate. KEY IDEAS 1. Classical economists believed that changes in the money supply affect the price level. Their position was based on the equation of exchange and the simple quantity theory of money. 2. The simple quantity theory of money can be analyzed using the AD-AS framework. 3. A more general theory of the factors that cause changes in the price level states that the price level depends on the money supply, velocity, and Real GDP. 4. Monetarists believe that changes in the money supply or velocity have different effects in the short run and the long run. 5. All four of the factors that are affected by changes in the money supply—the supply of loans, Real GDP, the price level, and the expected inflation rate—affect either the supply of or demand for loanable funds, and, therefore, affect the interest rate. CHAPTER OUTLINE I. MONEY AND THE PRICE LEVEL Classical economists believed that changes in the money supply affect the price level. Their position was based on the equation of exchange and the simple quantity theory of money. A. The Equation of Exchange The equation of exchange is an identity that states that M V P Q, where M = the money supply (usually thought of as M1), V = the velocity of money, P = the price level, and Q = real output, or Real GDP. Velocity is the average number of times a dollar is spent to buy final goods and services in a year. We measure velocity by dividing nominal GDP by the money supply, that is V GDP/M The equation of exchange can be interpreted in three different ways: 1. The money supply multiplied by velocity must equal the price level times Real GDP. 137

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138 Chapter 9 2. The money supply multiplied by velocity must equal GDP. 3. Total spending (measured by MV) must equal the total sales revenues of business firms (measured by PQ). B.
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Chapter-9 - CHAPTER 9 Money the Price Level and Interest...

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