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Wize AP Macroeconomics Textbook > Money and Prices in the Long Run

Velocity of Money

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Velocity of Money

The Velocity of money (V) is the rate at which money changes hands. It is equal to nominal GDP divided by the quantity of money.

V= P∗Y M\boxed{\text{V} =\ \frac{P *Y}{\ M}}
Where:
V - Velocity of money
P - Price level
Y - Real output (GDP) P * Y - Nominal GDP
M - Quantity of money (or money supply)

Example: If the price of each pizza is $10 and there are 100 pizzas made (consumed) and the quantity of money in the economy is $50, then the velocity of money =
(10 * 100) / 50 = 20
. This means each dollar has to change hands on average 20 times per year.

  • Quantity Equation - the equation that relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services (nominal GDP).

M * V = P * Y \boxed{\text{M * V = P * Y }}

  • The velocity of money is relatively stable. If the central bank increases the quantity of money it causes the price level and inflation to
    increase