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