The degree of relationship between the demand for and the supply of money in Fisher’s equation will be
- 𝑠𝑢𝑝𝑝𝑙𝑦 > 𝑑𝑒𝑚𝑎𝑛𝑑
- 𝒔𝒖𝒑𝒑𝒍𝒚 = 𝒅𝒆𝒎𝒂𝒏𝒅
- 𝑠𝑢𝑝𝑝𝑙𝑦 < 𝑑𝑒𝑚𝑎𝑛𝑑
- None of the above
Correct answer: b. supply=demand
Clearly, the correct answer (b) is “supply = demand.” In other words, the amount of money people want to hold (demand for money) corresponds to the amount of money available in the economy (money supply). For the economy to be stable, this equilibrium condition must be met.
There will be no excess or shortage of money in the economy when the supply of money equals the demand for money. It ensures that, people have enough money to conduct their transactions and preventing inflation from occurring.
Why the other options are not correct
a. Supply> demand
An excess supply of money in the economy occurs when the money supply (M) exceeds the money demand (D). The excess money will chase the same amount of goods and services, resulting in a higher demand for goods than their supply. As a result, prices would rise as a consequence, resulting in inflation.
This option is incorrect because if there will be a shortage of money in the economy if there is a difference between the money supply (M) and the money demand (D). People would desire to hold more money than is available in this situation, leading to a liquidity crunch. Deflation and economic downturn are possible consequences of this shortage of money, which reduces consumer spending and investment.
d. None of the Above
In option (d), none of the relationships mentioned in options (a), (b), and (c) are correct. However, we have already established that option (b) is correct, since the money supply is indeed equal to the demand for money (M = D). Therefore, option (d) is incorrect.
According to Fisher’s equation of exchange, the supply and demand of money are equal (supply = demand). In other words, the amount of money in the economy matches what people want to possess. As long as the supply and demand of money are in balance, price stability is maintained and inflation or deflationary pressures are avoided.
Incorrect options suggest either an excess or a shortage of money, both of which may negatively impact the economy. The excess supply of money can lead to inflationary pressures, whereas the shortage can lead to deflation and economic contraction.