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Dr.P.Madhusoodanan Pillai


Medium of exchange: replacement for barter (used to purchase item instead of exchanging for another i.e. barter) Standard of value: we use money to compare the values of commodities. Store of value: for the purpose of saving (as long as we are confident that it will keep/store its present value and therefore retain its purchasing power in the future when we come to use it) Means of deferred payment: being able to borrow money and pay it back over a relatively long period of time.

Portability: can be carried around easily (in wallet or pocket) Durability: must be able to stand the test of time without disintegrating

Divisibility: be able to divide into smaller units to enable a wide range of transactions e.g. $1 = 100cents. Recognisability: not easily copied (forged)

Acceptability: the legal status of money is given as legal tender by government

Relative scarcity: an increase in the money supply can lead to a fall in its value. People need to be confident that the value of their money will be maintained by the government (via controlling the amount of money circulating in the economy)

Suggests that both V (speed of circulation) and Q (output of goods and services) are constant.
Therefore M (the money stock) is proportional to P (general price level).

Which implies that the general price level will rise with an increase in the money stock, and fall with a decrease in the money stock.

M = the money stock V = the velocity/speed of circulation P = the general price level Q = total output (GDP)

If the money supply is increased by 15% this will mean that there is MORE money in circulation chasing the same quantity of goods. This in turn bids up prices as the purchasing power of each dollar falls. The end result will be a proportional increase in the price level, i.e. 15% increase in P.

Assumes only V (velocity of circulation) is constant, as the output of goods and services produced can change. Therefore if the money stock was to increase, this could lead to either a rise in the general price level (P) OR an increase in output (Q).

The economy is operating near full capacity there will be very little room for Q to increase, therefore the P (general price level) will rise. If the economy is operating under full capacity it has the potential to utilize idle resources to off-set inflation (rise in P).

A business cycle is identified as a sequence of four phases:

Contraction (A slowdown in the pace of economic activity-recession phase) Trough (The lower turning point of a business cycle, where a contraction turns into an expansion) Expansion (A speedup in the pace of economic activity) Peak (The upper turning of a business cycle)

Economic activity


Downturn/ recession



As an economy experiences an upturn/recovery, the level of economic activity increases (i.e. unemployment falls and output rises). Resources become more fully utilized, therefore any increase in M will become MORE inflationary as Q reaches full capacity. After the peak (boom) economic activity will decline and resources become more available as output falls and unemployment rises. A rise in M could be absorbed by rises in Q rather than increasing the general price level.