How do changes in money supply affect the price level? Explain using the Cambridge
approach to the quantity theory of money.
Answers
Answer:
Explanation:
Monetary economics is a branch of economics that studies different theories of money. One of the primary research areas for this branch of economics is the quantity theory of money (QTM). According to the quantity theory of money, the general price level of goods and services is proportional to the money supply in an economy. While this theory was originally formulated by Polish mathematician Nicolaus Copernicus in 1517, it was popularized later by economists Milton Friedman and Anna Schwartz after the publication of their book, "A Monetary History of the United States, 1867-1960," in 1963.1
According to the quantity theory of money, if the amount of money in an economy doubles, all else equal, price levels will also double. This means that the consumer will pay twice as much for the same amount of goods and services. This increase in price levels will eventually result in a rising inflation level; inflation is a measure of the rate of rising prices of goods and services in an economy.
The same forces that influence the supply and demand of any commodity also influence the supply and demand of money: an increase in the supply of money decreases the marginal value of money–in other words, when the money supply increases, ceteris paribus, the buying capacity of one unit of currency decreases. As a way of adjusting for this decrease in money's marginal value, the prices of goods and services rises; this results in a higher inflation level.