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Questions and Answers
What occurs to the aggregate demand curve when the money supply expands from M0 to M1?
What occurs to the aggregate demand curve when the money supply expands from M0 to M1?
- It remains unchanged.
- It shifts upward. (correct)
- It shifts downward.
- It shifts leftward.
What happens to the price level after the money supply increases to M1?
What happens to the price level after the money supply increases to M1?
- The price level fluctuates randomly.
- The price level remains constant.
- The price level increases. (correct)
- The price level decreases.
According to the classical theory, what must happen to the nominal wage rate after a rise in price level to restore real wage?
According to the classical theory, what must happen to the nominal wage rate after a rise in price level to restore real wage?
- It must remain the same.
- It must increase. (correct)
- It must vary based on employment levels.
- It must decrease.
In the neutrality of money concept, which of the following remains unchanged despite an increase in the money supply?
In the neutrality of money concept, which of the following remains unchanged despite an increase in the money supply?
What economic role does money primarily perform according to the classical theory?
What economic role does money primarily perform according to the classical theory?
What is the relationship between supply and demand for labor following a rise in the price level to P1?
What is the relationship between supply and demand for labor following a rise in the price level to P1?
After a rise in the money supply, how is the original level of employment NF determined again?
After a rise in the money supply, how is the original level of employment NF determined again?
Following the adjustment of money wages, what ultimately does this imply for real wages?
Following the adjustment of money wages, what ultimately does this imply for real wages?
What is a primary alternative to holding money as mentioned in the classical theory?
What is a primary alternative to holding money as mentioned in the classical theory?
What effect does the change in money supply have on real variables, according to the neutrality of money?
What effect does the change in money supply have on real variables, according to the neutrality of money?
What happens to the equilibrium price level when the money supply is increased from M0 to M1?
What happens to the equilibrium price level when the money supply is increased from M0 to M1?
How does the increase in money supply to M1 affect the demand for money at the initial price level P0?
How does the increase in money supply to M1 affect the demand for money at the initial price level P0?
In the classical model, why is the aggregate supply curve considered to be perfectly inelastic?
In the classical model, why is the aggregate supply curve considered to be perfectly inelastic?
What occurs in response to households wanting to reduce their money holdings after a money supply increase?
What occurs in response to households wanting to reduce their money holdings after a money supply increase?
With the increase in the money supply to M1, what happens to the new equilibrium point?
With the increase in the money supply to M1, what happens to the new equilibrium point?
What is the relationship described by the aggregate supply curve in classical theory?
What is the relationship described by the aggregate supply curve in classical theory?
What is the role of firms when households increase their spending on goods and services?
What is the role of firms when households increase their spending on goods and services?
What will households require more of as prices rise following an increase in money supply?
What will households require more of as prices rise following an increase in money supply?
What equilibrium is established after the money supply is increased to M1 and price level rises to P1?
What equilibrium is established after the money supply is increased to M1 and price level rises to P1?
At price level P0, what was the previous equilibrium before the money supply increased?
At price level P0, what was the previous equilibrium before the money supply increased?
What is the primary reason inflation is considered a serious concern?
What is the primary reason inflation is considered a serious concern?
Which aspect of Say’s Law does Keynes criticize?
Which aspect of Say’s Law does Keynes criticize?
What happens if entrepreneurs do not invest in proportion to desired savings, according to Keynes?
What happens if entrepreneurs do not invest in proportion to desired savings, according to Keynes?
How does inflation specifically impact income distribution?
How does inflation specifically impact income distribution?
What role does savings play in the context of production and demand?
What role does savings play in the context of production and demand?
What does Keynes state about investment in the economy?
What does Keynes state about investment in the economy?
What is the likely consequence of a decline in producer profits due to insufficient demand?
What is the likely consequence of a decline in producer profits due to insufficient demand?
Which statement best summarizes Keynes's view on classical economic theory's approach to demand?
Which statement best summarizes Keynes's view on classical economic theory's approach to demand?
According to Keynes, what is the relationship between production, demand, and employment?
According to Keynes, what is the relationship between production, demand, and employment?
What is a critical factor that determines consumer spending in an economy?
What is a critical factor that determines consumer spending in an economy?
According to classical economists, which factor is predominantly responsible for determining the price level in an economy?
According to classical economists, which factor is predominantly responsible for determining the price level in an economy?
In the equation of exchange MV = PY, what does 'V' represent?
In the equation of exchange MV = PY, what does 'V' represent?
What assumption is made about the velocity of money in classical theory?
What assumption is made about the velocity of money in classical theory?
How is the level of aggregate output determined according to classical theory?
How is the level of aggregate output determined according to classical theory?
What is the relationship between money supply and price level when both velocity and aggregate output are constant?
What is the relationship between money supply and price level when both velocity and aggregate output are constant?
What does Say's law indicate about resource employment in the economy?
What does Say's law indicate about resource employment in the economy?
In classical theory, which factor influences the demand for money?
In classical theory, which factor influences the demand for money?
Which equation correctly represents the relationship between money supply, velocity, output, and price level?
Which equation correctly represents the relationship between money supply, velocity, output, and price level?
Which of the following statements about aggregate output in the short run according to classical theory is correct?
Which of the following statements about aggregate output in the short run according to classical theory is correct?
What is the effect of a general cut in wages on the overall economy?
What is the effect of a general cut in wages on the overall economy?
Why is the application of partial equilibrium analysis to the whole economy flawed?
Why is the application of partial equilibrium analysis to the whole economy flawed?
What assumption did classical economists, such as Pigou, incorrectly make about wage reductions?
What assumption did classical economists, such as Pigou, incorrectly make about wage reductions?
In classical economics, what is considered the normal state of employment in a free market economy?
In classical economics, what is considered the normal state of employment in a free market economy?
What was a key consequence of the great depression regarding unemployment?
What was a key consequence of the great depression regarding unemployment?
How do reductions in real wages specifically affect the demand for products in a single industry?
How do reductions in real wages specifically affect the demand for products in a single industry?
Study Notes
Classical Quantity Theory of Money
- The classical theory of money states that the price level in an economy is determined by the quantity of money.
- The Fisher's equation of exchange expresses this relationship: MV = PY, where M is the quantity of money, V is the income velocity of circulation of money, P is the price level, and Y is the level of aggregate output.
- Classical economists assume that the velocity of money (V) is constant and the level of aggregate output (Y) is determined by the supply of productive resources and technology.
- The aggregate output (Y) is assumed to be constant at the full-employment level of output in the short run.
- Therefore, if V and Y are constant, changes in the money supply (M) directly affect the price level (P) in the same proportion.
- This is the neutrality of money principle: changes in the money supply only affect nominal variables (e.g., prices) and not real variables (e.g., output, employment).
Determination of Price Level
- The demand for money in the classical theory is determined by the money value of transactions occurring in the economy, which is represented by PY.
- When the supply of money (M) equals the demand for money (PY/V), the equilibrium price level (P) is determined.
- If the money supply increases, people hold more money than they demand, leading to increased spending on goods and services.
- This increased spending causes firms to raise prices, increasing the demand for money for transactions purposes, and ultimately reaching a new equilibrium at a higher price level.
Classical Aggregate Supply Curve
- The classical aggregate supply curve is perfectly inelastic.
- This implies that the aggregate supply of output is fixed and does not respond to changes in the price level.
- This is due to the assumptions of full employment, fixed resources, and constant technology.
Keynesian Critique of the Classical Theory
- Keynes challenged Say's Law, which states that supply creates its own demand.
- Keynes argued that savings do not necessarily translate into investment, leading to a potential deficiency in aggregate demand.
- This can result in overproduction and involuntary unemployment.
- Keynes also criticized the classical assumption of flexible wages and how it leads to full employment.
- Keynes argued that wages are sticky, meaning they are slow to adjust downwards.
- This rigidity prevents the automatic adjustment of wages and prices in response to changes in demand, leading to persistent unemployment.
- Keynes's critique highlighted the importance of aggregate demand and government intervention in managing the economy.
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Description
Explore the fundamental concepts of the Classical Quantity Theory of Money, which posits that the price level is determined by the money supply. This quiz covers Fisher's equation of exchange and the neutrality of money, focusing on implications for aggregate output and price levels in an economy.
