Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 19: Q5. (page 404)

State and explain the basic equation of monetarism. What is the major cause of macroeconomic instability, as viewed by monetarists?

Short Answer

Expert verified

The basic equation of monetarism is MV = PQ.

Here, M is money supply, V is the velocity of money, P is price level, and Q is output level.

The major cause of macroeconomic stability, as viewed by monetarists, is government interference and inappropriate monetary policy.

Step by step solution

01

Monetarist equation

The left side of the equation of exchange, MV, represents the total amount spent by purchasers of output, while the right side, PQ, represents the total amount received by sellers of that output. The nation’s money supply (M) multiplied by the number of times it is spent each year (V) must equal the nation’s nominal GDP (= P × Q). The dollar value of total spending must equal the dollar value of total output.

02

Macroeconomic instability according to monetarism 

The monetarists view government interference by setting minimum wage laws, pro-union legislation, guaranteed prices for certain farm products, and pro-business monopoly legislation cause macroeconomic instability. In a monetary policy, the inappropriate increase in the money supply leads to inflation, the instability of real output and employment, and the inappropriate decline in the money supply leads to deflation and the instability of real GDP and employment.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

Suppose that the money supply and the nominal GDP for a hypothetical economy are \(96 billion and \)336 billion, respectively. What is the velocity of money? How will households and businesses react if the central bank reduces the money supply by $20 billion? By how much will nominal GDP have to fall to restore equilibrium, according to the monetarist perspective?

Suppose that the money supply is \(1 trillion and money velocity is 4. Then the equation of exchange would predict nominal GDP to be:

a. \)1 trillion.

b. \(4 trillion.

c. \)5 trillion.

d. $8 trillion

Place “MON,” “RET,” or “MAIN” beside the statements that most closely reflect monetarist, rational expectations, or mainstream views, respectively:

a. Anticipated changes in aggregate demand affect only the price level; they have no effect on real output.

b. Downward wage inflexibility means that declines in aggregate demand can cause a long-lasting recession.

c. Changes in the money supply M increase PQ; at first only Q rises, because nominal wages are fixed, but once workers adapt their expectations to new realities, P rises and Q returns to its former level.

d. Fiscal and monetary policies smooth out the business cycle.

e. The Fed should increase the money supply at a fixed annual rate.

If the money supply fell by 10 per cent, a monetarist would expect nominal GDP to __________.

a. rise

b. fall

c. stay the same

According to mainstream economists, what is the usual cause of macroeconomic instability? What role does the spending-income multiplier play in creating instability? How might adverse aggregate supply factors cause instability, according to mainstream economists?
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free