Define the quantity theory of money and show how it is related to ...

[mynx]

Define the quantity theory of money and show how it is related to the equation of exchange.
 
  What will be an ideal response?

Question 2

A monopolistically competitive firm is similar to
 
  A) a monopoly in the short run because it can make an economic profit in the short run and is similar to a perfectly competitive firm in the long run because it cannot make a positive economic profit.
  B) a perfectly competitive firm in the short run because it cannot make an economic profit in the short run and is similar to a monopoly in the long run because it can make an economic profit.
  C) a monopoly because it can make an economic profit in both the short run and long run.
  D) a perfectly competitive firm because its economic profit is equal to zero in both the short run and long run.

[Jayson]

Answer to Question 1

The quantity theory of money is the proposition that in the long run, an increase in the quantity of money brings an equal percentage increase in the price level (other things remaining the same). The equation of exchange states that the quantity of money multiplied by velocity of circulation equals the price level times real GDP, or M  V = P  Y. Divide both sides of this formula by V to obtain P = (M  V)  Y. This formula shows that when M increases, as long as V and Y do not change, P increases by the same percentage, which is the conclusion of the quantity theory of money.

Answer to Question 2

A