The GDP determined at current market prices is referred to as nominal GDP. Although nominal GDP usually rises in lockstep with the money supply, this is not always the case. Real GDP is an inflation-adjusted measure of a country’s GDP, often known as “constant-price,” “inflation-corrected,” or “constant-dollar GDP.” The relationship between real GDP and the money supply is less obvious. The productivity of economic agents and enterprises has a greater impact on real GDP.
Key Points
- Consumer spending, government spending, investment, and net exports all contribute to aggregate demand (AD).
- A drop in the money supply is accompanied by a corresponding decrease in nominal output, also known as GDP ( GDP ).
- Consumer spending will be affected by the reduction in the money supply. The AD curve will move to the left as a result of this decline.
- An rise in the money supply is accompanied by an equal increase in nominal output, or GDP (GDP).
- The expansion of the money supply will result in more consumer expenditure. The AD curve will move to the right as a result of this increase.
- Increased money supply leads to lower interest rates and more spending, resulting in an increase in AD.
What factors influence real GDP?
Adjustments for changes in inflation are factored into real GDP. This means that when inflation is high, real GDP is lower than nominal GDP, and vice versa. Positive inflation, without a real GDP adjustment, dramatically inflates nominal GDP.
What impact does the money supply have on the economy?
An rise in the money supply often lowers interest rates, which stimulates spending by generating more investment and putting more money in the hands of consumers. Businesses respond by expanding production and ordering more raw materials. The need for labor rises as company activity rises. If the money supply or its growth rate lowers, the opposite can happen.
What is the link between the money supply and the gross domestic product?
GDP and Money Supply: What’s the Connection? The value of money in circulation rises in general when the GDP growth rate shows increased economic productivity. This is due to the fact that each unit of currency can be exchanged for more value goods and services in the future.
When real GDP rises, what happens to real income?
Finally, evaluate the consequences of a rise in real gross domestic product (GDP) (GDP). Such an increase indicates that the economy is growing. As a result, looking at the implications of a rise in real GDP is the same as looking at how interest rates will change as a result of economic expansion.
GDP may rise for a variety of causes, which will be examined in more detail in the next chapters. For the time being, we’ll assume that GDP rises for no apparent reason and explore the implications of such a development in the money market.
Assume the money market is initially in equilibrium with real money supply MS/P$ and interest rate i$ at point A in Figure 18.5 “Effects of an Increase in Real GDP.” Assume, for the sake of argument, that real GDP (Y$) rises. The ceteris paribus assumption states that all other exogenous variables in the model will remain constant at their initial values. It means that the money supply (MS) and the price level (P$) are both fixed in this exercise. People will need more money to make the transactions required to purchase the new GDP, hence a growth in GDP will enhance money demand. In other words, the transactions demand effect raises real money demand. The rightward change of the real money demand function from L(i$, Y$) to L(i$, Y$) reflects this rise.
What causes the real GDP to rise?
A rise in aggregate demand drives economic growth in the short run (AD). If the economy has spare capacity, an increase in AD will result in a higher level of real GDP.
Factors which affect AD
- Lower interest rates – Lower interest rates lower borrowing costs, which encourages consumers to spend and businesses to invest. Lower interest rates cut mortgage payments, increasing consumers’ discretionary income.
- Wages have been raised. Increased real wages enhance disposable income, which encourages consumers to spend.
- Greater government expenditure (G), such as government investments in new roads or increased spending on welfare payments, both of which enhance disposable income.
- Devaluation. A decrease in the value of the currency rate (for example, the Pound Sterling) lowers the cost of exports and increases the volume of exports (X). Imports become more expensive as a result of depreciation, lowering the quantity of imports and making domestic goods more appealing.
- Confidence. Households with higher consumer confidence are more likely to spend, either by depleting their savings or taking out more personal credit. It encourages spending by allowing increased spending (C) (C).
- Reduced taxation. Consumers’ disposable income will increase as a result of lower income taxes, which will lead to increased expenditure (C).
- House prices are increasing. A rise in housing prices results in a positive wealth effect. Homeowners who see their property value rise will be more willing to spend (remortgaging house if necessary)
- Financial stability is important. Firms will be more eager to invest if there is financial stability and banks are willing to lend, and investment will enhance aggregate demand.
Long-term economic growth
This necessitates an increase in both AD and long-run aggregate supply (productive capacity).
- Capital increase. Investment in new manufacturing or infrastructure, such as roads and telephones, are examples.
- Increased labor productivity as a result of improved education and training, as well as enhanced technology.
- New raw materials are being discovered. Finding oil reserves, for example, will boost national output.
- Microcomputers and the internet, for example, have both led to higher economic growth through improving capital and labor productivity. New technology, such as artificial intelligence (AI), which allows robots to take the place of human workers, may be the source of future economic growth.
Other factors affecting economic growth
- Stability in the economy and politics. Stability is vital for convincing businesses that investing in capacity expansion is a sensible decision. When there is a surge in uncertainty, confidence tends to diminish, which can cause businesses to postpone investment.
- Inflation is low. Low inflation creates a favorable environment for business investment. Volatility is exacerbated by high inflation.
Periods of economic growth in UK
The United Kingdom saw substantial economic expansion in the 1980s, owing to a number of factors.
- Reduced income taxes increase disposable income, which leads to increased expenditure and, in turn, stimulates corporate investment.
- House prices rose, resulting in a positive wealth effect, equity withdrawal, and increased consumer spending.
What is the impact of supply and demand on the economy?
When demand is constant, the supply and prices of products and services have an inverse relationship. Prices tend to decrease to a lower equilibrium price and a greater equilibrium quantity of goods and services when supply for goods and services increases while demand remains constant. Prices tend to rise to a higher equilibrium price and a lesser quantity of goods and services when supply of goods and services falls while demand remains constant.
What do supply-side factors entail?
Increased production, according to supply-side economics, drives economic growth. Capital, labor, entrepreneurship, and land are the components of production. Supply-side fiscal policy aims to improve the business environment. Tax cuts and deregulation are two of its tools.