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How does the value of money relate to price level?

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Quick Answer

The value of money relates to price levels based on the quantity theory of money, according to San Jose State University Department of Economics. This theory states that the “amount of money in circulation determines the price levels.” As the supply of money increases in the market, the demand for money decreases. Professors Nouriel Roubini and David Backus of New York University explain that prices increase to compensate for the increase of currency in circulation.

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Full Answer

When the money supply fluxes up, the value of the dollar goes down. Each dollar has less purchasing power than it did before the increase in the money supply. According to the City Budget Office of Seattle, inflation is the increase in prices over a period of time. During times of inflation and hyperinflation, prices rise to meet the excess dollars available in the market. The U.S. government uses the Consumer Price Index to measure inflation, according to the Bureau of Labor Statistics. This represents the change in prices over a period, which indicates the decrease in the value of money.

According to New York University Professors, Nouriel Roubini and David Backus, lectures in macroeconomics: "the growth rate of money equals the growth rate of prices (inflation) plus the growth rate of output." Economists use the equation for the quantity theory of money and the equation exchange to measure the value of money and price levels. These calculations take the amount of money presently in the economy and times it by the velocity of money, and the sum equals to price times the quantity of gross domestic products.

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