Think about circular flow chart. Suppose an economy with one firm and one househ

Question

Think about circular flow chart. Suppose an economy with one firm and one household where the firm pays householder $4000 every month for the labor provided by householder to produce goods. After work, householder spends $4000 on the goods the firm produced. Then next period firm can pay $4000 to the householder again, and the cycle continues. Now suppose householder become twice as much productive as before, so firm pays the householder twice as much as before (wage equals marginal productivity of labor in perfect competitive market). By Theory of Money, MV=PY, if M stays the same and the firm pays the householder every half month ($4000) and householder buys every half a month as much as they did before in one month, what will happen?

a. P increases, V increases.

b. V increases, Y increases.

c. P increases, Y increases.

d. V increases, Y decreases.

e. V decreases, Y increases.

f. V decreases, Y decreases.

Explanation / Answer

MV=PY

M constant

so change in V = change in P + change in Y

Y increases twice

V also increases Twice as velocity of flow of money is now double that before.

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