The equation of exchange is given by MxV=PxQ, where M is the money supply, V is the velocity of money, P is the economy's price level, and Q is Real GDP.

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Chapter1: Making Economics Decisions
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5. The equation of exchange
The equation of exchange is given by M x V = PxQ, where M is the money supply, V is the velocity of money, P is the economy's price level,
and Q is Real GDP.
Suppose the following diagram shows the current aggregate demand (AD) and aggregate supply (AS) curves in a hypothetical economy.
PRICE LEVEL
1
O
2
3
REAL GDP (Trillions of dollars)
AD
0 2 0 2
?
Transcribed Image Text:5. The equation of exchange The equation of exchange is given by M x V = PxQ, where M is the money supply, V is the velocity of money, P is the economy's price level, and Q is Real GDP. Suppose the following diagram shows the current aggregate demand (AD) and aggregate supply (AS) curves in a hypothetical economy. PRICE LEVEL 1 O 2 3 REAL GDP (Trillions of dollars) AD 0 2 0 2 ?
What is the GDP of this economy?
$9 trillion
$12 trillion
$6 trillion
$15 trillion
If the velocity of money is 3, the money supply in this economy is
Adjust the previous graph to show the effects of a decrease in the money supply.
Based on the new price level, what must the new money supply be in the long run if the velocity of money remains at 37
$3 trillion
$1 trillion
$2.5 trillion
$2 trillion
Because velocity is assumed to be constant, the percentage decrease in the price level is the same as the percentage decrease in the
money supply. This illustrates the
simple quantity theory of money
Transcribed Image Text:What is the GDP of this economy? $9 trillion $12 trillion $6 trillion $15 trillion If the velocity of money is 3, the money supply in this economy is Adjust the previous graph to show the effects of a decrease in the money supply. Based on the new price level, what must the new money supply be in the long run if the velocity of money remains at 37 $3 trillion $1 trillion $2.5 trillion $2 trillion Because velocity is assumed to be constant, the percentage decrease in the price level is the same as the percentage decrease in the money supply. This illustrates the simple quantity theory of money
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