Question

1. Suppose the annual growth rate of real GDP for some fictional economy is 6%, the growth rate of velocity is 0%, and the growth rate of the money supply is 11%.
   1. Using the quantity theory of money, what is the current rate of inflation?
   2. Using the quantity theory of money, what will happen to the inflation rate if the growth of the money supply increases to 15%?
   3. Using the quantity theory of money, what will happen to the inflation rate if the growth of the money supply increases to 16%, and at the same time, the growth rate of velocity increases to 4%?
   4. Given what we know about the value of money, calculate the inflation rate for this economy if the value of money falls from 0.1429 to 0.0909. (not related to parts a-c)

Answer 1

a) Quantity theory of money : %change in M + % change in V = % change in P + % change in Y

% change in P ( Rate of inflation ) = 11% - 6% = 5%

b) Inflation Rate = 15% + 0% - 6% = 9%

c) Inflation Rate = 16% + 4% - 6% = 14%

d) Rate of inflation = (0.1429 - 0.0909 ) / 0.1429 * 100 = 36.39 %

When inflation occurs the value of money decreases . We calculate the decrease percentage with respect to initial value of money . Money can buy lesser quantity of goods due to inflation .