Question

Suppose that an economy is characterized by M = $3 trillion V = 2.5 P = 1.0 (the base index 100) (a) What is the real value of output (Q)? Instructions: Enter your response as a whole number. $ billion Instructions: Enter your answers as a percent rounded to the nearest whole number. (b) Now assume that the Fed increases the money supply by 10 percent and velocity remains unchanged. If the price level remains constant, by how much will real output increase? (Note: Use the following formula.) 2formula3.mml 10 % (c) If, instead, real output is fixed at the natural level of unemployment, by how much will prices rise? % (d) By how much would V have to fall to offset the increase in M? Instructions: Enter your response as a positive number rounded to two decimal places (do not include a (-) negative sign).

Answer 1

As per Quantity theory,

M x V = P x Y [Where Y: Real output]

(a)

$3 Trillion x 2.5 = 1 x Y

Y = $7.5 Trillion

(b)

$3 Trillion x 1.1 x 2.5 = 1 x Y

Y = $8.25 Trillion

Increase in Y = (8.25 / 7.5) - 1 = 1.10 - 1 = 0.10 = 10%

(c)

$3 Trillion x 1.1 x 2.5 = P x $7.5 Trillion

P = $8.25 Trillion / $7.5 Trillion = 1.1

Increase in P = (1.1 / 1) - 1 = 1.1 - 1 = 0.1 = 10%

(d)

$3 Trillion x 1.1 x V = 1 x $7.5 Trillion

V = $7.5 Trillion / $3.3 Trillion = 2.2727

Change in V = (2.2727 / 2.5) - 1 = 0.9091 - 1 = - 0.0909 = - 09.09%

Fall in V = 9.09%