Answer to Question #241054 in Macroeconomics for Mankirta

Question

Q1. 'Increase in money supply, leads to increase in only nominal variables and not real variables'. Explain this statement with the help of diagrams in the light of an economy which is characterised by fully flexible wages and prices.

Answer 1

The quantity of money that is printed through Central banks and Federal Reserve may affect wages as well as prices, however not economic structure or output. There may be shortages in wages to provide to respective groups which may lead to increase in the prices of respective currency. Such cases reflect on the exchange rate concept, where the rate of a currency is based on its demand within the market.