Question

If \(\mathrm{GNP}=\$ 600\) billion and the money supply is \(\$ 200\) billion, what is the velocity of money?

Short answer

The velocity of money in this economy is 3, meaning that each unit of currency is used 3 times in exchange for goods and services within the economy.

Step-by-step solution

Rewrite the equation for V

We need to rearrange the equation MV = PQ (or in this case, MV = GNP) to solve for the velocity of money (V). To do this, we can divide both sides of the equation by M, like so: V = GNP / M

Plug in the given values for GNP and M

Now, we can plug in the given values for GNP and the money supply (M) into the equation: V = (\$600 billion) / (\$200 billion)

Calculate V

Finally, we can calculate the velocity of money (V): V = (\$600 billion) / (\$200 billion) = 3 Thus, the velocity of money in this economy is 3. This means that, on average, each unit of currency is used 3 times in exchange for goods and services within the economy.

Key concepts

Gross National Product (GNP)

Gross National Product (GNP) is a fundamental economic indicator. It represents the total value of all goods and services produced over a specific time period by a country's residents. GNP provides a broad measurement of a nation’s overall economic activity and health.
To calculate GNP, we include:

• The total value of goods and services produced within the country.
• Income earned by residents from overseas investments.
• Excluding income earned within the domestic economy by foreign residents.

GNP is crucial because it helps to reflect the economic performance beyond just domestic borders. A higher GNP suggests a robust and thriving economy.

Money Supply

The money supply is the total amount of money available in an economy at a specific time. It includes all forms of money, such as cash, coins, and balances held in checking and savings accounts.
The money supply is typically measured through different aggregates like:

• M1: Physical currency and coin, demand deposits, traveler's checks, and other checkable deposits.
• M2: M1 plus savings deposits, time deposits less than 100K, and non-institutional money market funds.
• M3: M2 plus large time deposits, institutional money market funds, and larger liquid assets.

Understanding the money supply is essential for economic policy because it influences inflation, interest rates, and overall economic growth.

MV = PQ Equation

The MV = PQ equation is a fundamental concept in economics known as the equation of exchange. It reflects the relationship between money, its velocity, and the economy's output.
Here's what each variable represents:

• M: Money supply, the total amount of monetary assets available in the economy.
• V: Velocity of money, the rate at which money circulates through the economy.
• P: Price level, the average level of prices in the economy.
• Q: Quantity of goods and services produced, also called real output or real GDP.

The equation can be written as \( MV = PQ \). In this context, it shows how the money supply and its velocity relate to the total economic output and the price level.
By using this equation, one can understand how money is transformed into economic activity, allowing adjustments in policy to stabilize or stimulate the economy.