Question

Suppose that the money supply of a country is $75 billion and the velocity of money is 3. The economy's production capacity is expected to grow by 4 percent over the next year. According to a strict monetarist perspective, what should be the total money supply by the end of the year in order to support the expected increase in capacity?

Answer 1

According to quantity theory equation,

MV = PY

Where,

M = Money supply

V = Velocity of money

P = Price level

Y = Real output

So,

75 * 3 = $225 billion

If economy's production capacity is expected to grow by 4% over the next year. The new value of PY = 225 * 1.04 = $234 billion.

Since velocity of money is constant at 3,

The total money supply by the end of the year = 234 / 3 = $78 billion.

Thus, in order to support the expected increase in capacity, the total money supply by the end of the year should be $78 billion.