Question

If velocity and aggregate output are reasonably constant (as the classical economists believed), what happens to the price level when the money supply increases from $\$ 1$ trillion to $\$ 4$ trillion?

Name: Problem 2, Chapter 19: The Economics of Money, Banking, and Financial Markets
Uploaded: 2021-09-29T06:10:52-08:00
Duration: 3 min 40 s
Channel: Md.Daniyal Arshad
Description: If velocity and aggregate output are reasonably constant (as the classical economists believed), what happens to the price level when the money supply increases from 1 trillion to 4 trillion?

   If velocity and aggregate output are reasonably constant (as the classical economists believed), what happens to the price level when the money supply increases from
$\$ 1$ trillion to $\$ 4$ trillion?

The Economics of Money, Banking, and Financial Markets

Frederic S. Mishkin 10th Edition

Chapter 19, Problem 2

Instant Answer

Solved by Expert Md.Daniyal Arshad

09/29/2021

Step 1

The formula for percentage change is given by: \[ \text{Percentage change} = \frac{{\text{New Value} - \text{Old Value}}}{{\text{Old Value}}} \] In this case, the old value is the initial money supply, which is \$1 trillion, and the new value is the final money Show more…

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If velocity and aggregate output are reasonably constant (as the classical economists believed), what happens to the price level when the money supply increases from $\$ 1$ trillion to $\$ 4$ trillion?

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Key Concepts

Quantity Theory of Money

This theory posits that the amount of money in circulation, when multiplied by the velocity of money, equals the price level multiplied by the aggregate output. It implies that if the money supply increases while velocity and output remain constant, the price level will increase proportionally.

Equation of Exchange

Represented by M × V = P × Y, this equation links money supply (M), velocity (V), price level (P), and aggregate output (Y). With V and Y constant, any change in M directly affects P, meaning an increase in M leads to a proportional increase in the price level.

Classical Economic Assumptions

Classical economists assumed that both aggregate output and the velocity of money are stable or grow independently of money supply changes. Under these assumptions, adjustments in the money supply directly translate into changes in price levels, a view that underpins the reasoning behind proportional inflation.

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