Economics Hand Book
Economics exam orientated question and solutions
Money
Explain the quantity theory of money?
The quantity theory of money was first propounded in 1588 by an Italian economist. The credit for popularizing this theory in recent years rightly goes to the American economist, Irving fisher, who gave it a quantitate form in terms of his famous equation of exchange. At present there are two versions of the quantity theory of money. * The transaction approach * The cash balance approach
The transaction approach is associated with the name of Irving fisher.
According to him “the quantity theory of money states that there is direct relationship between the quantity of money in an economy and the level of prices of goods and services.”
Another way to understand this theory is to recognize that money is like any other commodity increase in its supply decrease its marginal utility/value (buying capacity of one unit of currency) so increase in money supply causes price to rise (inflation) as they compensate for the decrease in money’s marginal utility. As a result money marginal utility decreases.
Assumptions
* No change in observed or included population, * No operation of illegal money, * Possibility to measure the velocity of money, * No change in the production capacity and technique of production, * No change in the allocation which affect the volume of production, and * No change in efficiency of management and quantity of money.
The theory calculation
MV=PT
Alternatively, it may also be expressed as,
P=MV/T
In this equation M represent the total amount of money in existence. V represents the velocity of circulation. MV therefore represents the amount of money used in a period.
Similarly, P represents the general price level, and T represents the total of all transaction that has taken place for money during the period.
This shows that when quantity of money increases, price level also increases on account of which value of
Money
Explain the quantity theory of money?
The quantity theory of money was first propounded in 1588 by an Italian economist. The credit for popularizing this theory in recent years rightly goes to the American economist, Irving fisher, who gave it a quantitate form in terms of his famous equation of exchange. At present there are two versions of the quantity theory of money. * The transaction approach * The cash balance approach
The transaction approach is associated with the name of Irving fisher.
According to him “the quantity theory of money states that there is direct relationship between the quantity of money in an economy and the level of prices of goods and services.”
Another way to understand this theory is to recognize that money is like any other commodity increase in its supply decrease its marginal utility/value (buying capacity of one unit of currency) so increase in money supply causes price to rise (inflation) as they compensate for the decrease in money’s marginal utility. As a result money marginal utility decreases.
Assumptions
* No change in observed or included population, * No operation of illegal money, * Possibility to measure the velocity of money, * No change in the production capacity and technique of production, * No change in the allocation which affect the volume of production, and * No change in efficiency of management and quantity of money.
The theory calculation
MV=PT
Alternatively, it may also be expressed as,
P=MV/T
In this equation M represent the total amount of money in existence. V represents the velocity of circulation. MV therefore represents the amount of money used in a period.
Similarly, P represents the general price level, and T represents the total of all transaction that has taken place for money during the period.
This shows that when quantity of money increases, price level also increases on account of which value of