Illustration
If, for example, in a very small economy, a farmer and a mechanic, with just $50 between them, buy new goods and services from each other in just three transactions over the course of a year
- Farmer spends $50 on tractor repair from mechanic.
- Mechanic buys $40 of corn from farmer.
- Mechanic spends $10 on barn cats from farmer.
then $100 changed hands in the course of a year, even though there is only $50 in this little economy. That $100 level is possible because each dollar was spent on new goods and services an average of twice a year, which is to say that the velocity was . Note that if the farmer bought a used tractor from the mechanic or made a gift to the mechanic, it would not go into the numerator of velocity because that transaction would not be part of this tiny economy's gross domestic product.
Read more about this topic: Velocity Of Money
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