Suppose an economist believes that the price level in the economy is directly related to the money supply, or the amount of money circulating in the economy. The economist proposes the following relationship:P=A×MP=A×M•P=Price LevelP=Price Level•M=Money SupplyM=Money Supply•A=A composite of other factors, including real GDP, that change very slowly over time.A=A composite of other factors, including real GDP, that change very slowly over time. How might an economist gather empirical data to test the proposed relationship between money and the price level?

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Asked Sep 10, 2019
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Suppose an economist believes that the price level in the economy is directly related to the money supply, or the amount of money circulating in the economy. The economist proposes the following relationship:
P=A×MP=A×M
P=Price LevelP=Price Level
M=Money SupplyM=Money Supply
A=A composite of other factors, including real GDP, that change very slowly over time.A=A composite of other factors, including real GDP, that change very slowly over time.
 
How might an economist gather empirical data to test the proposed relationship between money and the price level?
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Expert Answer

Step 1

The quantity theory of money says that there is a direct relationship between the price level and the quantity of money circulating in the economy. It can be denoted as:

MV= PT

M=Money Supply , P=Price Level , V= Velocity of money circulation, T= Number of transactions

Step 2

It can also be said that:

P=A×M

Where,P=Price Level,M=Money Supply, A=A composite of other factors,...

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