Equation of Exchange AP Macroeconomics

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Presentation transcript:

Equation of Exchange AP Macroeconomics

Where we came from… We learned about the properties, functions, and definitions of money. How is money defined?  M1 what’s included?  M2 what’s included?

Where are we going?  In this lesson, we’ll learn about the relationship between the money supply and GDP.  The Equation of Exchange is an identity and provides an understanding of the relationship between money and economic activity.

So what is this equation? MV=PQ This shows the relationship between money supply, income velocity, the price level, and real output.

Definitions Money supply (M) = stock of money Income velocity (V) = income (GDP) velocity of circulation, or average number of times $1 is spent on final goods and services in a time period. (think rate of change) Price level (P) = average price level of final goods and services in GDP, also known as the GDP deflator Real Output (Q) = real output, the quantity of goods and services in GDP. The equation of exchange is an accounting definition or an identity: it is always true.

The outcome of changes in (M) For the most part, income velocity is pretty predictable; its value remains in a narrow range over many years. Changes in (M) result in changes in nominal GDP (P x Q) Depending on the state of the economy, changes in money supply can result in changes in prices only, output only, or some combo of both.

Explain! If the aggregate supply curve is horizontal, an increase in the money supply will cause the AD curve to shift to the right, and only output will increase.

Explain! If the AS curve is vertical, an increase in money supply will cause the AD curve to shift to the right, and only price level will increase.

Explain! If the AS curve is positively sloped, an increase in money supply will cause the AD curve to shift to the right, and the economy will experience increases in both the price level and output. determination/deck/842177

And now… Some resources: Morton workbook Activity 36

Works Cited Economics of Seinfeld. Krugman, Paul, and Robin Wells. Krugman’s Economics for AP. New York: Worth Publishers. Morton, John S. and Rae Jean B. Goodman. Advanced Placement Economics: Teacher Resource Manual. 3 rd ed. New York: National Council on Economic Education, Print. Reffonomics.