Problem 4 In the simple quantity theory of... [FREE SOLUTION]

Chapter 14: Problem 4

In the simple quantity theory of money, what will lead to an increase in aggregate demand? In monetarism, what will lead to an increase in aggregate demand?

Short Answer

Expert verified

In both the simple quantity theory of money and monetarism, an increase in the money supply can lead to an increase in aggregate demand. This can be achieved through easing of monetary policies such as lowering interest rates and open market operations. In monetarism, factors like consumer and business confidence can additionally influence aggregate demand.

Step by step solution

Understanding Aggregate Demand

Aggregate demand refers to the total amount of goods and services demanded in an economy at a given overall price level and in a given time period.

Increase in Aggregate Demand in Simple Quantity Theory of Money

In the simple quantity theory of money, an increase in the money supply will signal an increase in aggregate demand. This is based on the assumption that there is a direct relationship between the money supply and the country's overall spending, and thus the aggregate demand. Such increase in money supply can be achieved through central bank's monetary policies, such as lowering interest rates, open market operations and reserve requirement decrease.

Increase in Aggregate Demand in Monetarism

Monetarism, a macroeconomic concept which is an extension of the quantity theory of money, posits that changes in money supply also have major influences on national output in the short run and on price levels over longer periods. Therefore, according to monetarists, expanding money supply will drive up aggregate demand as it will lower interest rates, encouraging spending and investment. Additionally, an increase in consumer and business confidence can also increase the aggregate demand.