Write the equation of exchange. Define each variable in the equation and then explain why the left side of the equation must equal the right.

MV=PQ

Take a shot, what does it mean an why must the left = the right.

Explain Bot Explain Bot answered
9 months ago

The equation of exchange, MV=PQ, is a fundamental equation in macroeconomics that describes the relationship between the money supply (M), the velocity of money (V), the price level (P), and the quantity of goods and services produced (Q).

Let's define each variable in the equation:

- M represents the money supply, which refers to the total amount of money in an economy.
- V represents the velocity of money, which measures how quickly money circulates in the economy. It is defined as the average number of times a unit of money is spent on final goods and services in a given time period.
- P represents the price level, which is the average price of goods and services in an economy.
- Q represents the quantity of goods and services produced, which is a measure of the real output of an economy.

Now, let's understand why the left side of the equation must equal the right side:

The left side of the equation, MV, represents the total amount of money spent in an economy over a given time period. It is calculated by multiplying the money supply (M) by the velocity of money (V). This represents the total monetary value of transactions made in the economy.

The right side of the equation, PQ, represents the total monetary value of all goods and services produced in an economy. It is calculated by multiplying the price level (P) by the quantity of goods and services produced (Q).

The left side of the equation (MV) must equal the right side (PQ) for the equation of exchange to hold true. This is because the total value of money spent in an economy (MV) should be equal to the total value of goods and services produced (PQ). In other words, the amount of money spent on goods and services should be equal to the value of those goods and services.

If the left side does not equal the right side, it implies a mismatch between the money spent and the goods and services produced, leading to either inflation or deflation. For example, if the left side is greater than the right side, it indicates an increase in the money supply or an increase in the velocity of money without a corresponding increase in the quantity of goods and services produced, which can result in inflation. Conversely, if the left side is smaller than the right side, it may indicate a decrease in the velocity of money or a decrease in the money supply relative to the quantity of goods and services produced, leading to deflation. Therefore, to maintain economic stability, the left side of the equation must equal the right side.