Question

Assume the money supply is $600, the velocity of money is 6, and the price level is $3. Using the quantity theory of money: a. Determine the level of real output. b. Determine the level of nominal output. c. Assuming velocity remains constant, what will happen if the money supply rises 20 percent? Nominal output would be $?? and real output would be $?? d. If the government established price controls and also raised the money supply 5 percent, what would happen? Instructions: You may select more than one answer. Click the box with a check mark for correct answers and click to empty the box for the wrong answers.

Answer 1

a) According to quantity theory of money : MV = PY

600 * 6 = 3Y

3Y = 3600

Y = 3600 / 3 = 1200

Thus, the level of real output is 1200.

b) The level of nominal output = P * Y = $3 * 1200 = $3,600

c) If the money supply rises 20 percent (i.e., from 600 to 720), nominal output will rise by 20 percent (i.e., from $3,600 to $4,320) but real output will stay the same.

d) If the government established price controls and also raised the money supply 5 percent, according to the quantity theory, an increase in the money supply that was not allowed to have an impact on the price level would have to be accompanied by either an increase in the quantity of goods sold or a decrease in the velocity of money.