NAME: Aimel Hasan

ROLL NO.: 20I-0203

DEGREE: BS- A&F
SUBJECT: Macro Economics
SUBMITTED TO: Sir Ayub
Contents
Question 1...................................................................................................................................................3
Question 2...................................................................................................................................................4
REFERENCES:...............................................................................................................................................8
Question 1
Explain the Quantity Theory of Money (QTM) and discuss its significance
for the Macro economy of a country using mathematical expressions.
The Quantity theory of money suggests that money supply and price level in an economy are
directly proportional to each other. It relates to difference of changes in price levels with respect
to change in quantity of money. This theory considers the inflation with respect to GDP deflator
and links inflation with growth of money supply. According to this theory for instance if the
amount of money supply rises in economy and triples so price levels will also rise by triple,
keeping all other factors as constant, this is main crucks of the theory. This increase in price
further leads to rise in inflation leading to macro-economic objectives not being fulfilled causing
purchasing power of consumers to decline too as affordability reduces when prices rises. There
are certain assumptions that are considered while keeping this theory in hand. Firstly, it assumes
that the money supply of an economy greatly effects the economic activity in economy and
circular flow is highly affected through it. It also assumes that change in money supply is one of
fundamental reasons behind increased or decreased people spending’s. As when money supply
increases people have more cash so prices of goods and services rise too hence restraining to
spend more leading to less circulation of currency notes in economy. This theory helps analyze
the velocity of money i.e. circulation of currency notes in a given time period. Velocity is an
important component because it measures the expenditure attitude of residents in a country. With
all these there are some implications linked to QTM too. It implies that countries that have high
money growth rate face high rate of inflation, this is because when too much money is printed so
currency loses its value hence for purchase of one single commodity more dollars are required
causing inflation. Second to that it needs to be checked whether in the long run the behavior of
both inflation and money growth rate is same or different. Hence, the Quantity theory shows a
one to one relation between money growth rate and changes in inflation rate. This Theory is very
significant for macro economy of a country because it is a simple way to see relationship that
money supply and price level hold and informs economists regarding expenditure pattern of
residents of a country which helps to determine the well-being of the country and judge the
consumption pattern too. The downside of this theory is that it cannot be used for short run time
periods as it is only useful in long run frame.
The equation for Quantity theory of money is as:
MV=PY
Here M represents Total amount of money in the economy or the broad money
V represents the velocity which is rate at which money circulates, Velocity can be calculated as
V= T/M
Where V is velocity, T is value of all the transactions in the economy and M is the money
supply. For total transactions the nominal GDP is taken which makes the equation in form
V= PY/ M
Where P is the price of output (GDP deflator), Y is quantity of output (Real GDP) and PY
together imply the value of output and show the nominal GDP.
Now as the theory assumes that V is constant and an exogenous variable so V= V (bar) as money
is directly related to output when v is constant.
So now equation is written as
MV(bar) = PY
The lesson that is learnt from QTM is that if growth of output is slow but money supply is high
so inflation is caused.

Question 2
Now using the annual data from 1980 to 2020 for the Economy of Pakistan,
on the variables related to the QTM, critically evaluate how for the
Quantity Theory of Money applies to the Economy of Pakistan?

Statistical
methods
Descriptive statistics
   
Mean 2.174544
Standard Error 0.049513
Median 2.204357
Mode #N/A
Standard
Deviation 0.317041
Sample Variance 0.100515
Kurtosis -0.78291
Skewness 0.035332
Range 1.270486
Minimum 1.603125
Maximum 2.873611
Sum 89.15629
Count 41
 YEARS Velocity
1980 2.406238697
1981 2.563130196
1982 2.451432137
1983 2.279105288
1984 2.509092278
1985 2.459341897
1986 2.308951218
1987 2.206966715
1988 2.417478143
1989 2.565354903
1990 2.555120088
1991 2.561405596
1992 2.351281177
1993 2.204357027
1994 2.202143773
1995 2.295112657
1996 2.171963469
1997 2.074549454
1998 2.120880366
1999 2.231134049
2000 2.873611408
2001 2.738596632
2002 2.475822168
2003 2.294448018
2004 2.227586165
2005 2.198810774
2006 1.773943999
2007 1.698724585
2008 1.835952364
2009 1.937004197
2010 1.904295948
2011 2.078999194
Broad
2012 Money 1.942457835
and GDP comparison
45000000000000 2013 1.914225063
40000000000000 2014 1.929481633
35000000000000
2015 1.87538641
2016 1.748832916
30000000000000
2017 1.746593769
25000000000000
RS BILLION

2018 1.72440794
20000000000000
2019 1.698943956
15000000000000
2020 1.603125382
10000000000000
5000000000000
0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20
YEARS

Broad money (current LCU) Million Rs GDP (current LCU) Million Rs

 Velocity
3.5

2.5
VELOCITY OF CIRCULATION

1.5

0.5

0
80 82 84 86 88 90 92 94 96 Velocity
98 00 02 04 06 08 10 12 14 16 18 20
19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20
3.5 YEARS
3
VELOCITY OF CIRCULATION

2.5

1.5

0.5

0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20
YEARS
If we analyze the economy of Pakistan we can observe that the GDP rose at higher speed, then
money growth. More goods and services were produced within the geographical boundaries of
country but the notes printed or the broad money was less in comparison to that. The velocity of
circulation of Pakistan does not follow a fixed upward or downward trend but fluctuates over the
years. Over the last 40 years the maximum money circulation in economy has been 2.873611 and
minimum has been 1.603125. The variation in expenditure by Pakistani residents varies to about
1.270486. In Pakistan both money supply and GDP has risen over the years but the proportion
differs leading to variation in velocity. When money supply has increased more than GDP
percentage so an inflationary pressure has been placed on prices which reduces spending in
economy and that is why circulation declines as affordability of people decline and they inject
less money in circular flow. In the same way when GDP has risen more than money supply so
velocity of circulation has risen in those years for instance in year 2000 when it has been the
highest. This theory shows how Price levels in Pakistan are directly and proportionally affected
by the money supply in economy, because equal percentage change is observed in both. The
velocity of money shows the number of times that on average a dollar is used to buy the goods
plus services in one unit of time in an economy and when there is surge in money supply so
prices of products rise and the velocity grows at faster rate than des the real GDP.
Pakistan’s economy is not that stable that is why over the years in a bird’s eye view we observe
that velocity has decreased as Pakistani economy is not expending at a high rate and injection in
economy is lesser then leakage as savings might have risen leading to lesser flow of money.
REFERENCES:
 https://data.worldbank.org/indicator/NY.GDP.MKTP.CN?locations=PK
 https://data.worldbank.org/indicator/FM.LBL.BMNY.CN?locations=PK