Question

Suppose the supply of money, measured by M1, is $2.4 trillion, output, measured by real GDP, is $19.9 trillion, and the velocity of money is 7.7. Suppose the supply of money increases to $4.0 trillion but GDP and the velocity of money do not change. What is the percent by which prices change? Provide your answer as a percentage rounded to two decimal places. Do not include any symbols, such as "$," "=," "%," or "," in your answer.

Answer 1

According to the quantity theory of money,

Money supply * Velocity = Real GDP * Price level

Money supply = $2.4 trillion

Real GDP = $19.9 trillion

Velocity = 7.7

Putting the values,

$2.4 trillion * 7.7 = $19.9 trillion * price level

Price level = ($2.4 trillion * 7.7)/$19.9 trillion

Price level = 0.93

The price level is 0.93

Now, money supply increases to $4 trillion.

Money supply = $4 trillion

Real GDP = $19.9 trillion

Velocity = 7.7

Putting the values,

$4 trillion * 7.7 = $19.9 trillion * price level

Price level = ($4 trillion * 7.7)/$19.9 trillion

Price level = 1.55

The price level is 1.55

Calculate the percentage increase in the price level -

Percentage increase = [(1.55 - 0.93)/0.93] * 100

Percentage increase = 66.66%

Thus,

The prices changes by 66.66 percent.