Question

1. i) Let's consider a hypothetical economy where this year's money supply is Tk. 300, nominal GDP is Tk. 80000 and real GDP is Tk. 2000. a) What does the quantity theory of money say? b) Calculate the price level. c) Calculate the velocity of money d) Show stage b on a graph. ii) Describe briefly the tools the central bank uses to control the money supply in the economy, 3. a) Suppose economists observe that an increase in government spending of 200 crore taka raises the total demand for goods and services to 300 crore taka. If these economists ignore the possibility of crowding out effect, calculate the marginal propensity to consume (MPC)? b) Now suppose economists allow for crowding out. Would their new estimate of the MPC be smaller or larger than your answer to part a, explain?

Answer 1

Given that,

Money supply, m = 300

Nominal GDP, = 80,000

Real GDP = 2000

(a) Quantity theory of money says that the product of money supply and velocity of money is equal to the product of real GDP and price level in an economy.

mV = pY

(b)

Price level = 40

(c) Velocity of money can be calculated by the following formula:

Money suppy * velocity of circulation of money = Price level * Real GDP

300 * V = 40 * 2000

V = 266.67

(d) The graph is shown as follows:

In following graph, initial full-employment equilibrium is at point A where AD (aggregate demand) and LRAS (long-run aggregate supply) curves intersect with initial equilibrium price level P0 (= 40) and initial equilibrium real GDP Y0 (= 2000).