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Chapter 14: Problem 2

Can the money supply support a GDP level greater than itself? Explain your answer.

Short Answer

Expert verified
Yes, the Money Supply can support a GDP level greater than itself. The key factor making this possible is the velocity of money, which indicates how frequently each unit of currency is used in economic transactions within a given time frame.

Step by step solution

01

Define Money Supply and GDP

First, it is important to define the key terms for a clear understanding: Money Supply represents the total amount of currency and other liquid instruments in a country's economy as of a particular time. Gross Domestic Product (GDP) is the total monetary or market value of all finalized goods and services produced within a country's border in a specific time period.
02

Understand the connection between Money Supply and GDP

It is necessary to understand how the Money Supply and GDP interact. According to the Equation of Exchange (MV=PQ), where M=Money Supply, V=Velocity of Money, P=Price Level, and Q=Output (GDP), the total spending in an economy (MV) must equal the total income (PQ). Now, if V (how frequently a unit of currency is used to purchase goods and services) is greater than 1, Money Supply (M) can be less than GDP.
03

Conclusion

In conclusion, the Money Supply can support a GDP level greater than itself. This is possible due to the velocity of Money (V), which indicates the rate at which money is exchanged from one transaction to another in an economy. If this velocity is high, a lower Money Supply can support a higher GDP because each unit of currency is used for multiple economic transactions in a given time frame.

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Most popular questions from this chapter

According to monetarism, an increase in the money supply will lead to a rise in Real GDP in the long run. Do you agree or disagree with this statement? Explain your answer.

Explain how demand-induced, one-shot inflation may seem like supply-induced, one-shot inflation.

What is the difference in the long run between a one-shot increase in aggregate demand and a one-shot decrease in short-run aggregate supply?

In monetarism, how will each of the following affect the price level in the short run? a. An increase in velocity b. A decrease in velocity c. An increase in the money supply d. A decrease in the money supply

"One-shot inflation may be a demand-side (of the economy) or a supply-side phenomenon, but continued inflation is likely to be a demand-side phenomenon." Do you agree or disagree with this statement? Explain your answer.
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