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# ec-7 - Long-Run Effects of Money When the economy is at...

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Long-Run Effects of Money When the economy is at Full employment and there is an Increase in the Quantity of Money we see two very different results in the economy during the short-run and the long-run. In chapter 14 will see that, in the short run, an increase in the quantity of money lowers the interest rate and increases aggregate demand. The increase in aggregate demand increases both real GDP and the price level. However, in the long run, the shortage of labor brings a rise in the money wage rate so that the short-run aggregate supply decreases. This is the long-run adjustment mechanism we discussed in chapter 12. 26

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This suggests that in the long run, a change in the quantity of money affects the price level but has no effect on real GDP. THE QUANTITY THEORY OF MONEY Let, M = quantity of money V = velocity of money ( average number of times each dollar in the money supply is used to purchase goods and services Included in GDP ) P = price level (the GDP deflator) Y = RGDP. Recall from chapter 7 that Nominal GDP = PY . P = NGDP/RGDP 27
In the 1920s, Irving Fisher formalized the connection between money and prices using the quantity equation (or called the equation of exchange, more common) which is, MV = PY The equation of exchange states that the quantity of money, M , multiplied by the velocity of circulation, V , equals GDP.

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ec-7 - Long-Run Effects of Money When the economy is at...

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