Question

What is the basic quantity equation of money?

Short answer

The basic quantity equation of money is \( MV = PQ \), where \( M \) represents the money supply, \( V \) denotes the velocity of money, \( P \) is the price level, and \( Q \) stands for the real Gross Domestic Product (GDP). This equation illustrates the relationship between the total value of transactions in an economy and the total value of goods and services produced.

Step-by-step solution

Write down the quantity equation of money

The basic quantity equation of money is given by: \[ MV = PQ \]

Explain the variables

In the equation, the variables represent the following: - \( M \): This represents the money supply in an economy. It refers to the total amount of money available in an economy at a particular point in time. - \( V \): This is the velocity of money. It represents the average number of times a single unit of currency is used in transactions during a specific period of time (usually a year). In simple terms, it is how fast money circulates through the economy. - \( P \): This denotes the price level, which measures the average price of goods and services in the economy. It is often represented by a price index, such as the Consumer Price Index (CPI) or the GDP deflator. - \( Q \): This stands for the real Gross Domestic Product (GDP). It is a measure of the total value of goods and services produced by an economy, adjusted for inflation, in a specific period of time.

Understand the relationship among variables

The equation states that the total value of transactions in an economy (the product of money supply and the velocity of money, or \(MV\)) is equal to the total value of goods and services produced in the economy (the product of price level and real GDP, or \(PQ\)). This equation helps economists understand the factors that may cause inflation or deflation, as changes in the money supply (M), velocity of money (V), or both, can lead to changes in the price level (P).