Classical Quantity Theory of Money
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Classical Quantity Theory of Money

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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?

  • 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?

  • 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?

    <p>Aggregate output</p> Signup and view all the answers

    What economic role does money primarily perform according to the classical theory?

    <p>Medium of exchange</p> Signup and view all the answers

    What is the relationship between supply and demand for labor following a rise in the price level to P1?

    <p>Demand for labor exceeds supply of labor.</p> Signup and view all the answers

    After a rise in the money supply, how is the original level of employment NF determined again?

    <p>By the equilibrium of supply and demand for labor.</p> Signup and view all the answers

    Following the adjustment of money wages, what ultimately does this imply for real wages?

    <p>They restore to the original level.</p> Signup and view all the answers

    What is a primary alternative to holding money as mentioned in the classical theory?

    <p>Purchasing goods and services.</p> Signup and view all the answers

    What effect does the change in money supply have on real variables, according to the neutrality of money?

    <p>They remain constant.</p> Signup and view all the answers

    What happens to the equilibrium price level when the money supply is increased from M0 to M1?

    <p>The equilibrium price level rises.</p> Signup and view all the answers

    How does the increase in money supply to M1 affect the demand for money at the initial price level P0?

    <p>Demand for money decreases as people hold more money than needed.</p> Signup and view all the answers

    In the classical model, why is the aggregate supply curve considered to be perfectly inelastic?

    <p>Output is fixed in the short run regardless of price changes.</p> Signup and view all the answers

    What occurs in response to households wanting to reduce their money holdings after a money supply increase?

    <p>Households will increase their spending on goods and services.</p> Signup and view all the answers

    With the increase in the money supply to M1, what happens to the new equilibrium point?

    <p>It develops at point E1 on the demand for money curve.</p> Signup and view all the answers

    What is the relationship described by the aggregate supply curve in classical theory?

    <p>No correlation between price and quantity of goods supplied.</p> Signup and view all the answers

    What is the role of firms when households increase their spending on goods and services?

    <p>Firms will increase prices of their goods and services.</p> Signup and view all the answers

    What will households require more of as prices rise following an increase in money supply?

    <p>More money to hold for transaction purposes.</p> Signup and view all the answers

    What equilibrium is established after the money supply is increased to M1 and price level rises to P1?

    <p>Demand for money and supply of money are equal.</p> Signup and view all the answers

    At price level P0, what was the previous equilibrium before the money supply increased?

    <p>Demand for money equaled supply at M0.</p> Signup and view all the answers

    What is the primary reason inflation is considered a serious concern?

    <p>It adversely affects economic growth and lowers living standards.</p> Signup and view all the answers

    Which aspect of Say’s Law does Keynes criticize?

    <p>Supply does not necessarily create its own demand completely.</p> Signup and view all the answers

    What happens if entrepreneurs do not invest in proportion to desired savings, according to Keynes?

    <p>Involuntary unemployment may arise due to excess supply.</p> Signup and view all the answers

    How does inflation specifically impact income distribution?

    <p>It hurts the poor the most, widening the inequality gap.</p> Signup and view all the answers

    What role does savings play in the context of production and demand?

    <p>Not all saved income creates demand for goods and services.</p> Signup and view all the answers

    What does Keynes state about investment in the economy?

    <p>Entrepreneurs' investment plans can be misaligned with actual savings.</p> Signup and view all the answers

    What is the likely consequence of a decline in producer profits due to insufficient demand?

    <p>Producers may reduce their level of production and cause unemployment.</p> Signup and view all the answers

    Which statement best summarizes Keynes's view on classical economic theory's approach to demand?

    <p>It overlooks the importance of aggregate demand in product markets.</p> Signup and view all the answers

    According to Keynes, what is the relationship between production, demand, and employment?

    <p>Insufficient demand can lead to unemployment, regardless of production levels.</p> Signup and view all the answers

    What is a critical factor that determines consumer spending in an economy?

    <p>The income levels and savings behavior of consumers.</p> Signup and view all the answers

    According to classical economists, which factor is predominantly responsible for determining the price level in an economy?

    <p>The supply of money</p> Signup and view all the answers

    In the equation of exchange MV = PY, what does 'V' represent?

    <p>Velocity of circulation of money</p> Signup and view all the answers

    What assumption is made about the velocity of money in classical theory?

    <p>It is constant and does not change.</p> Signup and view all the answers

    How is the level of aggregate output determined according to classical theory?

    <p>By the availability of productive resources</p> Signup and view all the answers

    What is the relationship between money supply and price level when both velocity and aggregate output are constant?

    <p>An increase in money supply results in a proportionate increase in price level.</p> Signup and view all the answers

    What does Say's law indicate about resource employment in the economy?

    <p>All resources are fully employed without intervention.</p> Signup and view all the answers

    In classical theory, which factor influences the demand for money?

    <p>The money value of transactions occurring in the economy</p> Signup and view all the answers

    Which equation correctly represents the relationship between money supply, velocity, output, and price level?

    <p>PY = MV</p> Signup and view all the answers

    Which of the following statements about aggregate output in the short run according to classical theory is correct?

    <p>It remains constant when resources are fully utilized.</p> Signup and view all the answers

    What is the effect of a general cut in wages on the overall economy?

    <p>It leads to a deficiency in demand for goods and services.</p> Signup and view all the answers

    Why is the application of partial equilibrium analysis to the whole economy flawed?

    <p>It ignores the interdependence of various economic sectors.</p> Signup and view all the answers

    What assumption did classical economists, such as Pigou, incorrectly make about wage reductions?

    <p>That individual industries operate independently from the overall economy.</p> Signup and view all the answers

    In classical economics, what is considered the normal state of employment in a free market economy?

    <p>Full employment with spontaneous correction of deviations.</p> Signup and view all the answers

    What was a key consequence of the great depression regarding unemployment?

    <p>Widespread unemployment affected a quarter of the labor force.</p> Signup and view all the answers

    How do reductions in real wages specifically affect the demand for products in a single industry?

    <p>They have a negligible effect on the overall demand for that product.</p> Signup and view all the answers

    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.

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