10. Economic Performance - Quantity Theory of Money Flashcards
Who came up with the quantity theory of money and what is it?
Developed by Irving Fisher the quantity theory if money states; there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold (inflation).
What is the formula for the quantity theory of money?
MV = PQ M = Money SupplyV = Velocity of CirculationP = Average Price LevelQ = Quantity of goods/services sold
Why does MV = PQ?
By definition the 2 sides must balance bc;Money Supply x Velocity of Circulation = Total Expenditure in an economy (what’s bought)Average Price Level x Quantity of goods/services sold = total output (what’s sold)Whats bought must have been sold by somebody and whats sold must have been bought - therefore the 2 have to be equal
How does the equation show the factors affecting inflation?
If you reword the same equation you get P = MV/QAverage Price levels (inflation) are dictated by the money supply, velocity of circulation and quantity of goods and services sold.
How would a monetarist claim inflation is directly determined by the money supply alone?
A monetarist would say that V is broadly fixed with only marginal variations in booms and recessions and data suggest Q is also fixed. If you remove these from the equation you end up with M = P.
How would a Keynsian economist challenge this view?
They’d argue that V is actually highly variable - e.g. in the credit crunch, banks stopped lending bc of the liquiduty trap so V fell dramatically
