i) The Quantity Theory of Money (Theory of Exchange) looks at money
largely from the supply side while Keynesian approach is from the demand
perspective (the desire for people to hold their wealth in cash balances
instead of interest – earning assets such as treasury bills and bonds)
Early quantity theorists maintained that he quantity of money (M) is
exogenously determined (eg. by the quantity of notes printed), and that the
velocity (v) and the volume of transactions (T) are constant. This means that
in the equation of exchange (MV = PT) if the money supply (M) is doubled
the price level (P) is going to increase proportionately, thus the assertion of
the quantity theorists that the price level varies in direct proportion to
changes in the quantity of money, leaving real variables (such a aggregate
demand & unemployment) unchanged.
By keeping the velocity of money constant, money appears as a technical
input to spending, that is, a certain quantity of money is required per unit of
spending; there is no indication that the velocity of circulation of money
might be affected by the decisions of people themselves to hold money.
The Keynesian view, however, maintains that the more people tend to want
to keep their wealth in liquid form (eg. cash and cheques/current/sight
accounts) rather than time deposits or long-term loans, the smaller the
proportion of the existing stock of money that can be lent out by financial
institutions to be spent by borrowers. Thus, the more people wish to hold
reserves of liquidity in money balances the lower will tend to be the velocity
of circulation of money.
Keynes argued in the General Theory of Employment, Interest and Money
(1936) that velocity (V) can be unstable as money shifts in and out of ‘idle’
money balances reflecting changes in people’s liquidity preference. The
supply of money is exogenously determined by the monetary authority and
therefore interest – inelastic, and what actually causes changes in real
economic variables is the frequency of change in the velocity of money an
argument which the Quantity Theory of money doesn’t recognize, since it
holds constant the velocity of money (V).
Other than for transactions purposes, Keynes argued that the demand for
money depends on the wave of pessimism concerning real world prospects
which could precipitate a ‘retreat into liquidity’ as people seek to increase
their money holdings. This increase in money holding would lower the
velocity of circulation of money and thus aggregate demand would fall
bringing about economic recession.
The demand for money, according to Keynes, is for three motives:
transactions, precautionary and speculative motives, arguing that the demand
for money is positively related to income and negatively related to interest
rate, which should not fall below the investors’ normal rate of interest.
ii) M = 500
V = 8
P = 2
MV = PT
500(8) = 2T
T = (4,000)/2 = 2000
PT = the money value of all transactions in the economy and therefore
represents the nominal value of output.
?
PT = (2 x 2000) = 4000
Gregorymasila1 answered the question on March 2, 2018 at 19:19
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