Answer to Question #220711 in Macroeconomics for fatma

Question

Demonstrate using the classical model how a decrease in the money supply, a

decrease in income velocity and a rise in the transactions demand for money

would affect prices, money wages and real variables.            

Answer 1

Solution:

According to the classical model, the quantity of money demanded is always equal to the quantity of money supplied. So, when there is a decrease in money supply, the price level will decrease in the same amount as the money supply. At the same time, the decrease in money supply will lead to a decrease in the money wages in the same proportion as the money supply. The real variables will remain unchanged with the decrease in the money supply.

 

A decrease in income velocity will lead to a decrease in price levels, including a drop in money wages and a decrease in real variables.

 

A rise in the transaction demand for money will lead to an increase in the price levels, including a decrease in money wages and a decrease in the real variables.