Answer the following questions:
a. What is the equation of exchange? Explain each component.
b. What assumptions are placed on the equation of exchange to generate the quantity theory of money?
c. Explain the quantity theory of money and what it implies about the impact of changes in the money supply on real output and prices.
a. The equation of exchange is MV = PY. M is the money stock (usually measured by M1 or M2), V is the velocity of money, P is the aggregate price level, and Y is real output. PY thus equals nominal GDP.
b. The quantity theory of money assumes that Y and V are constant (or at least determined by factors other than the amount of money in circulation).
c. The quantity theory of money states a proportional relationship between prices and the quantity of money in circulation. In this framework, changes in the money supply cause a proportional change in prices and do not affect real output.
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Archie wants to buy a steak for dinner. When he goes by the store, he sees that the price of steak has gone up a lot since the previous week. He decides to buy hot dogs instead. The __________ means that even though Archie has the same amount of money he did last week, that money won’t buy the same amount of steak today.
a. income effect b. substitution effect c. inflationary effect d. deflationary effect
A common tool for restricting trade through taxation is:
A. immigration restrictions. B. a tariff. C. quota. D. international waters use policies.
With capitalism, the allocation of goods and resources is determined by
a. market forces b. centralized planning c. government policy d. traditional customs
An aggregate supply curve shows the
a. Level of real domestic output which will be produced at each possible price level b. Level of real domestic output which will be purchased at each possible price level c. Price level at which real domestic output will be in equilibrium d. Price level at which real domestic output will be purchased