Question

Suppose that this year's money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5 trillion.

The price level is ______, and the velocity of money is ______.

.

Suppose that velocity is constant and the economy's output of goods and services rises by 4 percent each year. Use this information to answer the questions that follow.

If the Fed keeps the money supply constant, the price level will _______ (rise by 4%, stay the same, fall by 4%) , and nominal GDP will _______ (rise by 8%, fall by 4%, stay the same, rise by 4%, fall by 8%).

True or False: If the Fed wants to keep the price level stable instead, it should increase the money supply by 4% next year.

True

False

If the Fed wants an inflation rate of 9 percent instead, it should _______ (increase, decrease) the money supply by _____%.

. (Hint: The quantity equation can be rewritten as the following percentage change formula: (Percentage Change in M)+(Percentage Change in V)=(Percentage Change in P)+(Percentage Change in Y)Percentage Change in M+Percentage Change in V=Percentage Change in P+Percentage Change in Y.)

Answer 1

M x V = P x Y where (P x Y) = Nominal GDP

% Change in M + % Change in V = % Change in P (Inflation) + % Change in Y

(1)

Price level = Nominal GDP / Real GDP = 10 trillion / 5 trillion = 2

V = (P x Y) / M = 10 trillion / 0.5 trillion = 20

(2)

0% + 0% = % Change in P + 4%

% Change in P = - 4%

Price level will fall by 4%.

Nominal GDP stay the same.

(3) True

% Change in M + 0% = 0% + 4% = 4%

(4)

% Change in M + 0% = 9% + 4% = 13%

It should increase money supply by 13% (assuming Y increases by 4% as mentioned in previous part).