Under normal circumstances, the velocity of circulation of money in a country is
- 100 %
- Less than 10
Correct Answer: c. Less than 10
Money usually circulates at a velocity of less than 10 in a country under normal circumstances. In order to support transactions in the economy, the velocity of circulation of money (V) measures how often a unit of currency changes hands within a specified period of time.
In monetary economics, it is one of the most important concepts and plays an important role in understanding how the money supply, price level, and economic output are related.
If the velocity is low, it indicates that money circulates slowly, which may indicate a sluggish economy with reduced spending and lower economic activity. Conversely, higher velocity indicates a faster circulation of money, a sign of a robust economy resulting in increased transactions and greater economic output.
For economic stability and growth, policymakers and economists closely monitor the velocity of money to gain insight into economic trends.
Why the other options are not correct
A velocity of 100% implies that money changes hands only once per period. In other words, each unit of currency is used for a single transaction and then immediately exchanged for another good or service.
Despite being theoretically possible, the situation is not realistic in real-world economies. Due to saving, precautionary motives, and the time it takes for transactions to take place, money circulates slowly in practice. Under normal circumstances, a velocity of 100% is rare.
For example: If an economy has an overall money supply of $100 billion and nominal spending of $100 billion, the velocity of money is 1 ($100 billion/$100 billion). During the measurement period, each unit of currency was used on average once.
If the velocity of money is negative, it implies that money is being removed from circulation, which contradicts the fundamental concept of money as a medium of exchange. Money facilitates transactions, and its circulation is essential for the functioning of an economy. Negative velocity is not feasible, and it is inconsistent with the concept of money.
Example: The negative velocity of currency indicates that each unit is hoarded instead of being used for transactions, resulting in economic stagnation.
As money serves as the primary medium of exchange in modern economies, a velocity of zero would indicate that no transactions take place in the economy. In spite of economic recession and stagnation, some level of economic activity and transactional usage of money persists, resulting in a positive velocity value.
As an example, if the total money supply in an economy is $100 billion, and the total nominal spending is $0, the velocity of money would be 0 ($0/$100 billion).
In conclusion, under normal circumstances, the velocity of circulation of money in a country is typically less than 10. The velocity of money measures how frequently money changes hands in the economy and influences the overall level of nominal spending.
Despite the fact that it is theoretically possible to have a velocity of 100%, it rarely occurs because of savings, precautionary motives, and the time it takes for transactions to take place. As money is a medium of exchange, negative and zero velocities aren’t feasible.
For analyzing economic activity, formulating monetary policies, and promoting economic stability and growth, understanding the velocity of money is essential. In order to ensure an economy functions efficiently, policymakers and economists closely monitor the velocity of money.