Teaching Money, Prices, Income, and the Quantity Theory of Money

By Vo, Han X. | Journal of Economics and Economic Education Research, January 2004 | Go to article overview

Teaching Money, Prices, Income, and the Quantity Theory of Money


Vo, Han X., Journal of Economics and Economic Education Research


ABSTRACT

One problem often encountered in teaching macroeconomics, particularly at the principles level, is the abstract nature of the subject matter. In teaching the quantity theory of money, many students have difficulty with understanding the theory itself and the terms in that equation. In fact, for the students to comprehend the quantity of money, they first need to have a good grasp of such elusive concepts as the quantity of money, the velocity of money, as well as the distinction between nominal income and real income.

This paper describes a classroom simulation technique designed to teach the quantity theory of money and related concepts. The focus of the simulation is to use a concrete classroom situation to help the students relate to more abstract concepts and phenomena. The author has used this simulation to teach macro principles with good results. This paper has two parts: the first part deals with a discussion of simulation method and the second part, with the historical development and policy ramifications of the quantity theory.

The paper begins with an identification of the major problems that may be encountered in teaching the quantity theory to undergraduate students. It then proceeds to describe the simulation exercise in details. Basically, the exercise involves dividing the class into a producer side and a consumer side. The class receives a fixed amount of money and a fixed quantity of good. The students also receive clarifications of the meaning of each of the terms in the equation of exchange, MV = [SIGMA]PQ. After allowing a short period of "free" exchange of good for money between the two sides, the students were asked to compute the value of nominal income. To reinforce their understand of the equation of exchange, the simulation goes through a second and third round after changes in the money supply M and the quantity of goods or real income Q.

Upon completion of the simulation exercise, the instructor goes through the meaning of the quantity theory and policy implications. This second phase of the learning is designed to help the student see the functional linkages between money, prices, nominal income, and real income. The students seemed to enjoy a fresh change of venue and gain a better understanding of equation of exchange, a clearer idea about the quantity theory as a theory about money, price, and income.

INTRODUCTION

In undergraduate macroeconomic classes, at the principles level especially, teaching the quantity theory of money can sometimes be a challenging experience. From the students' perspective, the difficulties frequently arise from the first-time encounter with such elusive concepts as the supply of money, money's velocity, and the link between the quantity of money and the price level and nominal income. The challenge with teaching the quantity theory can also comes from student failure to grasp such measures as nominal GDP and real GDP. Even from the faculty's perspective, the modern quantity theory of money is not without controversy. In a nutshell, the controversy concerns the identity-vs.-equation issue, or about the role of money in stabilization policy, or the effectiveness of monetary policy. In other words, the controversy has revolved around issues regarding the nature and direction of causality between the major terms of the equation, namely, money, prices, and output. Interestingly enough, this controversy among economists also finds a parallel expression in the classroom, when the teacher may have a hard time explaining to his students the nexus of money-velocity-price-income relationships. This paper explores a complementary teaching technique aimed at addressing the pedagogical challenge stated above.

If the controversy among economists is concerned with Athe technical difficulty of sorting out the direction of causation running between money and prices," (Laidler 1991) to many undergraduate students, especially those taking principles of economics, the difficulty in understanding causality is further compounded by the abstract nature of entities such as the stock of money, velocity, and the general price level. …

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