Question

ECO - 252 Macroeconomics

7. Real output = $800 billion

Nominal output = $2,400 billion

The money supply = $200 billion

The reserve ratio = 10%

**a.** Find the velocity
of money (V) and the price level (P) consistent with the quantity
equation.

**b.** Assume that banks
loan out all excess reserves, people hold no currency, V is
constant and real output stays at $800 billion, but the Fed buys
$20 billion worth of government bonds from the public.

**What is the new money supply?**

**According to the quantity equation, what is the new price
level?**

**c.** Will the following
variables be affected by the change in money supply.
* For each, simply state YES or NO*.

**-** nominal output

**-** real interest
rate

**-** nominal wage
rate

**-** consumer price
index

**-** real GDP

**-** nominal income

**-** GDP deflator

**-** nominal GDP

Answer #1

We have the following relationships

- Real output = $800 billion, Nominal output = $2,400 billion, The money supply = $200 billion, The reserve ratio = 10%

**a.** Quantity theory suggests that P x Y = M x V.
Here nominal GDP is 2400 and money supply is 200. So velocity is
2400/200 = 12. V = 12. Price = nominal GDP/ Real GDP = 2400/800 =
3. P = 3

**b.** Monetary base increases by 20 billion and
money multiplier is 1/10% =1 0. Hence money supply increases by
20*10 = 200 billion. New money supply is 200 + 200 = 400
billion.

New price level is (M x V)/Y = (400 x 12)/800 = 6.

**c.** Under this case only those variables are
increased that are affected by price level or money supply.

**-** nominal output: Yes (It is P x Y)

**-** real interest rate: No

**-** nominal wage rate: Yes

**-** consumer price index: yes

**-** real GDP: No

**-** nominal income: Yes

**-** GDP deflator: Yes

**-** nominal GDP: Yes

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