The Equation of Exchange addresses the relationship between money and price level, and between money and nominal GDP.

The Velocity Of Money Money Supply Price Level Real Gdp
The Velocity Of Money Money Supply Price Level Real Gdp Equation
The Velocity Of Money Money Supply Price Level Real Gdp Equation

The velocity of money money supply price level real gdp

Velocity of Money = $4,800 / $200 Velocity of Money = 24 As seen above, the total GDP of this economy in this month was $400. The same kind of transactions happens throughout the year making the GDP to $4800 and the velocity of money for the year to 24.

Gross domestic product (GDP) measures everything produced by all the people and companies within a country's borders. Nominal GDP measures this output without adjusting for inflation. To calculate the velocity of money, you must use nominal GDO because the measure of the money supply also does not account for inflation. Money Supply x Velocity = Average Price Level x Real Output (GDP), or Money Supply x Velocity = Nominal GDP. Velocity represents the number of times (per year) money (one unit of currency) is used to purchase goods and services. Classical theory assumption: velocity is constant. Equation of Exchange Calculate the velocity of money if real GDP is 3,000 units, the average price level is $4 per unit, and the quantity of money in the economy is $1,500.

The equation simply states: M x V = P x Y

The Velocity Of Money Money Supply Price Level Real Gdp

Where M = the money supply, usually the M1

V = the velocity of money

P = the price level

Y = real output, or real GDP.

The Velocity Of Money Money Supply Price Level Real Gdp Equation

Velocity is the number of times the average dollar is spent to buy final goods and services in a given year. Velocity can be calculated by using V = (P x Y ) / M

The Velocity Of Money Money Supply Price Level Real Gdp Equation

The equation tells us that total spending (M x V) is equal to total sales revenue (P x Y). Since (P x Y) is equal to the nominal GDP, then M x V = nominal GDP.

Velocity (V) and Real GDP (Y) are effectively constant in the short run, therefore any changes in money supply (M), will cause a proportional change in the price level (P).

Re-writing the equation, we get: P = ( M x V ) / Y

This equation demonstrated a direct relationship between price and money supply. If V and Y are constant, a certain percentage change in money supply will cause a same amount of change in the price level.