Exercise Discuss the statements listed below in a
Exercise • Discuss the statements listed below in a paragraph. • Price of fruit set to rise after adverse growing season. • Price of electricity hits record levels • Petrol prices rise again • An increase in the price of an individual good or service cannot cause a general price rise, but can only cause a price rise in a particular market.
Quantity theory of money MV = PQ where M = money supply, V = velocity P= Price(general price level) Q= output/Real GDP Crude version considers V and Q to be constant. So any change in PL through inflation will also change the money supply and visa versa. M α P Any change in prices result in a proportionate change to the money supply. Increased growth (through increased consumption of G/S) leads to inflation.
Crude version continued • Velocity – the speed of money passing from person to person is considered predictable so the MS can be used to compensate for inflation changes e. g. through the official cash rate. • Limitation: with high inflation the general price level is increasing (P) velocity can change as people spend money rather than hold it as it is losing purchasing power. Q can also change. • MV and PQ are ways to measure the level of economic activity.
Sophisticated version • MV = PQ V is no longer always constant and Q depends on the part of the business cycle the economy is operating at to the change possible. M = PQ • Any increase in Money supply will proportionately increase PQ if Q can not increase then P increases more. • Full capacity i. e. boom will be inflationary as less options to increase production (output)Q (A) • Underutilised resources i. e. recession will be less inflationary as available resources that can increase production without increasing prices. (B)
Money supply • The money supply needs to be loose enough to enable growth but tight enough to maintain scarcity of money to maintain value. • When an economy has no idle resources any increase in MS will result in little change in Q but P will increase.
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