Answer to Question #225529 in Economics of Enterprise for Joy

Question

Explain how money stock and money velocity causes inflation. 

Answer 1

Inflation depends on money growth and the velocity of money. The velocity of money equals the average number of times an average dollar is used to buy goods and services per unit of time. So, prices increase when the product of the money supply and its velocity grows faster than real GDP. The quantity theory of money states that the supply and demand for money determine the rate of inflation. If the money supply grows, prices tend to rise. This is because each individual unit of currency becomes less valuable.