The quantity theory of money is an important tool for thinking about issues in macroeconomics.
The equation for the quantity theory of money is: M x V = P x Y
What do the variables represent?
M is fairly straightforward – it’s the money supply in an economy.
A typical dollar bill can go on a long journey during the course of a single year. It can be spent in exchange for goods and services numerous times. In the quantity theory of money, how many times an average dollar is exchanged is its velocity, or V.
The price level of goods and services in an economy is represented by P.
Finally, Y is all of the finished goods and services sold in an economy – aka real GDP. When you multiply P x Y, the result is nominal GDP.
Actually, when you multiply M x V (the money supply times the velocity of money), you also get nominal GDP. M x V is equal to P x Y by definition – it’s an identity equation.
You can think about the two sides of the equation like this: the left (M x V) covers the actions of consumers while the right (P x Y) covers the actions of producers. Since everything that is sold is bought by someone, these two sides will remain equal.
Up next, we’ll use the quantity theory of money to discuss the causes of inflation.
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MEK Imagine an economy where total spending is 100$ and there are only 20$. This means that the 20$ have been spent 5 times, in other words V is equal to 5. You just divide nominal gdp by the money supply and you get to velocity, simple as that.
How is Y Real GDP? Usually you use the price levels of 2009 in order to get real GDP. In this video they are refering real GDP as the value of all products and services in a year, which is technically just nominell GDP? Can someone explain please? But good video I must say!
The real GDP you are talking about is the nominal GDP adjusted for inflation. It used prices in a base year to neutralize inflation effects on GDP figures.
Here the real GDP is an abstract concept and is really supposed to really reprennent all goods and services actually bought in an economy in a given period.
Quantity theory of money is outdated. Doesn't work like that in the real world. I use to work in a bank. What they taught me in university was useless because i saw the real banking. Not the theory banking.
@A one legged man - TheRealNoodle is correct here. I suggest you watch 97% Owned (see link below) as it clearly sets out how and where money actually comes from.
TheRealNoodles, what did you do at "the bank"? What was their AUM? What country was this bank in? What type of bank was it? When was this? Where was this? What did you study at university? Where did you go to university? And why did you believe your critique was necessary to this video?
I apologize if I come across as condescending with the barrage of questions but I am legitimately curious. I myself had around 2 years at a "decently" sized bank (post fin cri 08) and I do feel like it is relevant for individuals (especially economists or branches thereof) to know this information.
DM my dude let's talk!
TheRealNoodles just because you didn't see it while working in banking doesn't means it isn't real or whatever you are trying to say. The central bank actions and policies have real effects that can be modeled with good accuracy.
And nobody said the central bank can control money supply at will.. It can't even measure it anyway.
Also the TQM is an identity, it's not right or wrong it is true by definition
M x V = P x Y
P x Y = Nominal GDP
Therefore, M x V = P x Y = Nominal GDP
Remember that to find nominal GDP you multiply real GDP (Y) by the price index or price level (P) which is the formula P x Y. Since the formula M x V is identically the same as the formula P x Y this is why money times velocity equals nominal GDP.
The amount of money in circulation (M) times the number of times each dollar is spent (V) is equal to nominal GDP because velocity (V) is the number of times each dollar is spent on *final goods and services* . Remember that's how we define nominal GDP - the total value of all sales of final goods and services before adjusting for inflation. Total money times the amount of times the money is spent on final goods equals the total value of sales of goods and services. For example, if there are 10 dollars in circulation (M=10) and each dollar is spent 5 times (V=5), 10 x 5 = 50. So the total amount of money spent on final goods and services would be $50 which would be the nominal GDP - the total value of the sale of all final goods and services before adjusting for inflation.
What would Ludwig Von Mises say about this? I thought money was simply a medium of exchange which took the inconvenience of not finding someone willing to trade their goods for your goods out of direct bartering. I don't know why the velocity of money would matter to the health of an economy or to the gross domestic product. It's production and trade that show overall economic health, right? I never could make sense of the Keynesian economic rationale and fiat currency. If you need to use force to get people to use your currency what does that say about its actual value?
It's because ppl fall prey to monetary illusions, a concept that Keynes introduced. Classics an Austrian live in a perfect world where prices and wages would always self ajust. In reality wages and prices can not ajust because ppl don't care about real wages
With reference to (almost) 2:44...do credit cards really count as money?
n how do they affect the currency printing process...they do accelerate the spendings and thus GDP, is there effect also considered when printing hard cash?
Credit card is not money. It is a borrowed promissory note that a bank is willing to put on its balance sheet. The asset of the credit card user increases, the liabilities of the card issuer increases too. Printing hard cash has a purpose. To complete transactions.
Credit cards don't count towards the money supply, however the money borrowed on credit from the bank (credit) will count toward the sale of final goods and services, which in turn affects the value of GDP (Y). Debitable/checkable accounts do count as money (M). The reason for this is because the money in your checkings/savings account can be converted back to actual physical currency at any point, whereas credit is where the whoever the credit card is through (usually a bank) has paid for the goods and services but with the promise you will eventually pay them back with real money, also generally with interest, as there would be no incentive to loan you money without receiving some type of return.
Y = Real GDP
P x Y = Price index times real GDP
Remember that to find nominal GDP you multiply real GDP (Y) by the price index or price level (P) which is the formula P x Y. This is why the formlula M x V is identically the same as the nominal GDP.
Hi Leo, I recommend heading on over to the beginning of the Macro course. We define GDP and explain the difference between nominal and real GDP in the first four videos. Here's a link to the playlist: https://www.youtube.com/watch?v=mjJmo5mN5yA&index=1&t=9s&list=PL-uRhZ_p-BM52EbMG1NR1ZfG9tEvcxE4u
Hope that clears it up! -Meg
We've studied this equation in relation with inflation and unemployment, m is the cause of inflation, government spending to boost employment is halted by the structural unemployment which thenly causes stagflation, and more money drowning the economy leading to skyrocketing prices and ultimately more inflation and more unemployment
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Outsource the Tedium to Technology.