3. The equation of exchange

The equation of exchange is given by MV=PQMV=PQ, where MMis the money supply, VVis the velocity of money, PPis the economy's price level, and QQis real GDP.

Suppose the following graph shows the current aggregate demand (ADAD) and aggregate supply (ASAS) curves in a hypothetical economy.

ADAS03691215181815129630PRICE LEVEL REAL GDP (Trillions of dollars)ADAS

The nominal GDP in this economy is

trillion.

If the velocity of money is 2, the money supply in this economy is.

Shift the ADADcurve on the previous graph to show the effects of a decrease in the money supply.

Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drags it a little farther.

Based on the new price level, the new money supply must be

trillionin the long run if the velocity of money remains at 2.

Because the percentage decrease in the price level is the percentage decrease in the money supply. This illustrates the.