Questions and Answers
What is the main relationship described by the quantity theory of money?
Direct relationship between money quantity and price levels
Who was the economist that introduced the cash transaction equation as part of the quantity theory of money?
Irving Fisher
What does Prof. Irving Fisher's cash transaction equation primarily focus on?
Money demand for transaction purposes
According to the quantity theory of money, what happens to the price level as the quantity of money in circulation increases?
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How is the value of money affected when the quantity of money in circulation decreases?
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Which equation is used to examine the quantity theory of money alongside Irving Fisher's cash transaction equation?
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According to the equation MV = PT, what does 'M' represent?
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In the extended equation P = M.V. + M₁V₁ / T, what does 'M₁' represent?
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What factor did Professor Fisher state directly affects the average price level (P) in the extended equation?
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Given M = 1000, V = 10, V₁ = 4, M₁ = 500, and T = 3000 units, what is the value of P in the example provided?
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How would an increase in the velocity of bank money (V₁) affect the average price level (P) according to the extended equation?
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What happens to the average price level (P) if the total number of goods and services (T) decreases according to the extended equation?
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Study Notes
Quantity Theory of Money
- States that the quantity of money and price levels are directly related, and the quantity of money and value of money are inversely related.
- When the quantity of money increases or decreases, the price level will also increase or decrease by the same proportion, and the value of money will decrease or increase.
Cash Transaction Equation
- Introduced by Prof. Irving Fisher, also known as the "American equation".
- Represents the demand for money for transaction purposes.
- Equation: M.V. = P.T.
- Where:
- M = Quantity of money
- V = Velocity of money (number of times units of money are used in circulation)
- P = Average (general) price level
- T = Total number of goods and services available in the economy for transaction
- The equation equalizes the supply of money (MV) and demand for money (PT).
Extended Cash Transaction Equation
- Extended equation: P.T. = M.V. + M₁V₁
- Where:
- M = Quantity of legal tender money
- V = Velocity of legal tender money
- M₁ = Quantity of bank money
- V₁ = Velocity of bank money
- T = Total number of goods and services (quantity of money)
- States that P varies directly with changes in the quantity of money (M and M₁), provided other factors like V, V₁, and T remain the same.
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