Suggested Answers for Mankiw Questions for Review & Problems

where k = 1/V . This equation tells us that for any fixed money supply M, a negative relationship exists between the price level P and output Y , assuming that velocity V is fixed: the higher the price level, the lower the level of real balances and, therefore, the lower the quantity of goods and services demanded Y . In other words, the aggregate demand curve slopes downward. One way to understand this negative relationship between the price level and output is to note the link between money and transactions. If we assume that V is constant, then the money supply determines the dollar value of all transactions: MV = PY . An increase in the price level implies that each transaction requires more dollars. For the above identity to hold with constant velocity, the quantity of transactions and thus the quantity of goods and services purchased Y must fall.