ch4b - The Quantity Theory of Money A simple theory linking...

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slide 0 CHAPTER 4 Money and Inflation The Quantity Theory of Money A simple theory linking the inflation rate to the growth rate of the money supply. Begins with the concept of velocity
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slide 1 CHAPTER 4 Money and Inflation Velocity basic concept: the rate at which money circulates definition: the number of times the average dollar bill changes hands in a given time period example: In 2007, $500 billion in transactions money supply = $100 billion The average dollar is used in five transactions in 2007 So, velocity = 5
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slide 2 CHAPTER 4 Money and Inflation Velocity, cont. This suggests the following definition: where V = velocity T = value of all transactions M = money supply
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slide 3 CHAPTER 4 Money and Inflation Velocity, cont. Use nominal GDP as a proxy for total transactions. Then, where P = price of output (GDP deflator) Y = quantity of output (real GDP) P × Y = value of output (nominal GDP)
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CHAPTER 4 Money and Inflation The quantity equation The quantity equation M × V = P × Y follows from the preceding definition of velocity. It is an
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ch4b - The Quantity Theory of Money A simple theory linking...

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