Question

Given the Equation of Exchange where MV=PQ, suppose that an economy is characterized by:

M= $2 trillion

V= 2.5

P= 1.0

a.) what is the real value of output (Q)?

Now assume that the Fed increases the money supply by 10 percent and velocity remains unchanged.

b.) if the price level remains constant, by how much will real output increase?

c.) if instead, real output is fixed at Q amount from part A, (which becomes the natural level of unemployment), and given the 10% increase in the money supply, by how much will prices rise?

d.) given the scenario described in part c, what is the new V?

e.) how much would V have to fall to offset the increase in M?

Answer 1

A) as MV = PQ

Q = (2*2.5)/1

Q* = $ 5 trillion

B) new M = 2 + 2*.1 = 2.2

P = 1

So According to Quantity Theory of Money

2.2*2.5 = 1*Q`

Q` = $ 5.5 trillion

So Real output level rises by $ .5 trillion

C)

Q = 5 , M = 2.2

So as MV = PQ

P = 2.2*2.5/5

P* = 1.1

So price rise by .1$

D) let new V = V`

Then M = 2.2, P = 1.1, Q = 5

So V` = P*Q / M

= 2.5

E) MV = PQ

So as PQ ( as in A) = 1*5 = 5

So new M = 2.2

Thus new V = PQ / M

V = 5/2.2 = 2.2727

so V falls by = 2.5-2.2727

= .22727 units

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