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# Quantity of money: Economics

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What is the effect of an increase in the quantity of money? What is the difference between real variables and nominal variables? Are these variables affected by the quantity of money? If so, how?

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Questions: What is the effect of an increase in the quantity of money? What is the difference between real variables and nominal variables? Are these variables affected by the quantity of money? If so, how?

Solution:
The effect of an increase in the quantity of money will lead to an increase in price level. The quantity theory of money says that there is a direct proportional relationship with the price level. In short, an increase in money supply will lead to inflation. For example, if the Federal Reserve reduces the Federal Rate, there will be an increase in the supply of money and an increase in inflation.

The difference between real and nominal variables is that, in case of a real variable, the effects of inflation have been factored in. However, in case of nominal variable the effects of inflation have not been accounted for. For example, the nominal GDP measures the value of all goods and services produced expressed in current prices. However, real gross domestic product gives the value of all goods and services produced expressed in prices of a base year.

The nominal variables are affected by the quantity of money but the real variable is not affected by the quantity of money. If there is inflation, the nominal variable increases because the effects of inflation have not been factored in. For example, the real interest rate is the nominal interest rate less the effect of inflation. The quantity of money affects inflation and the nominal rate of interest but it does not affect the real rate of interest.

References:
1. www.tutor2u.net/economics/revision.../a2-macro-monetarism.html