Question

Suppose that the Price level = 120, Supply of Money = $20 billion, and Real GDP = $4 billion. If the velocity of money stays the same but Real GDP increases by 20%, what will happen to the price level if the supply of money increases by $10 billion?

Select one:

a. It will increase to 125

b. It will increase to 132

c. It will increase to 144

d. It will increase to 150

e. It will increase to 155

2.

Which of the following is an example of a pro-cyclical government policy?

Select one:

a. The President providing tax credit for first time homebuyer during a financial crisis

b. The President raising spending on education during a recession

c. The Fed raising the Required Reserve Ratio during a recession

d. The Fed raising the Federal Funds Rate during an expansion .

e. Congress raising corporate taxes during an expansion

Answer 1

1. Quantity theory of money : MV=PY

M : Money supply

V: Velocity

P: Price level

Y : Real GDP

By putting the gives values , we get the velocity

($20 billion) V = (120)($4 billion)

V = (480 billion/ 20 billion)

V = 24 (Velocity of money)

Now , it is mentioned that Y increases by 20% . So, Y = (4) + (4)(20%) = $ 4.8 billion

And M increases by $10 billion , so M= $(20+10) billion = $30 billion

And V stays the same at 24

So, by putting these values into the equation MV=PY ,we get :

($30 billion)(24)= P ($4.8 billion)

P= $150

Hence,option(D) is correct i.e Price level will increase to 150.

2. An example of pro-cyclical government policy is the Fed raising the required reserve ratio during a recession. Because pro-cyclical government policy which is going in the same direction of the business cycle. Hence,option(C) is correct.