Economic Puzzle for Discussion
A miner borrows $100 for digging equipment. The bank loans him the money. He buys the equipment. He goes into the mountains, digs and brings back a chunk of gold worth $10,000. He sells the chunk of gold to a jewelry maker.
How might the variables in this equation be changed?
M * V = P * Q
The current values are…
M, money supply = 500,000
V, velocity of money = 2
P, price level = 1
Q, gross domestic production = 1,000,000
Comments and answers below…
Here’s my guess.
Assuming that gold is not being used for money, it sounds like Q and V should increase, but M and P stay constant. Of course, introducing more gold into the system might lower the price of gold and so lower P, so I am also assuming that $10,000 worth of gold is not enough to change price levels. (Granted, it is 1% of GDP, so it might.)
that aint no gold digger…that’s Hillary Clinton playing the commodities market..
The gold digger introduces $10,000 of value into the economy with a $100 loan. The result is deflationary, but quantity goes up. Money supply remains about the same. So it is more stuff, lower price, the left side remains the same.
Hint… bank created $100 of new money for the money supply. So M goes to $500,100.
How do the other variables change?
V = P*Q divided by M
You can do all different variations of this equation or solve it for M.
Yes there are different variations but this is not an algebra class. What is the important economic point here I think is the velocity of money in an economy can either make or break the economy. If you are at ZBD then you have no tools to stimulate velocity that in turn changes the other variables. This is why velocity of money flow in economies is so important to have and dreadful not to have…Right ,wrong indifferent? Money flows knows of no borders and flows like water going down hill and follows the path of least resistance…
Lambert’s puzzle demonstrates, well beyond any reasonable doubt, that subjecting any economic activity to an economist’s economic analysis is the least economical way by which one can explain, never mind measure, the effect on the economy of such economic activity. It’s not at all economical. It’s only concise.
W Ryan. I’m going to disagree with you when you say:
“the velocity of money in an economy
can either make or break the economy”
V is nothing more than nominal GDP divided by M2. V is just a number, it is not a variable. V is not a phenomenon that goes up or down when people, governments or businesses spend money more quickly as you seem to believe.
V has fallen from 2 to 1.4 since 2009. This happened because the Fed pumped up M2, but most of the money went to excess reserves and did not get into the economy.
https://fred.stlouisfed.org/series/M2V
EL gives us V in his question. But he should avoid V and replace it with Q/M. It is the same thing.
If there is no social or government economic discipline in the society then one who continues to print money into infinity we will not have a society.Yes we also can always kick the can down the road until the next generation has to deal with it but to me endless printing of ones currency will devalue it and is not the long term answer to stimulating the economy. Also without looking I doubt that it is the middle class that will eventually get most that “reserved money” in loans from the big 6…
Let me suggest a simple solution…
M rises by $100 to $500,100.
P rises to $1,000,200 through a multiplier process of 2x due to velocity of money. So the bank loan of $100 led to an increase of $200 in domestic production.
No change in the price level.
No change in velocity.
Even though a product was added to domestic production of $10,000, that product will compete for other products already on the market and crowd out many of them. The money that was spent on the gold will not be spent on other products. So sales will fall elsewhere, but the economy overall grows by $200 due solely to the bank loan and the velocity of money.
Comments?