Question

You are given a Simple Closed economy of one Good and one type of currency with...

You are given a Simple Closed economy of one Good and one type of currency with an initial (year 1) annual GDP of 5000 goods and a static money supply of 5000 units of currency.

What would you expect to happen to the price level and production of goods in this closed economy over time (10 years)?

Explain your answer and show supporting calculations.

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Answer #1

Prices generally tend to increase over time . Though US federal reserve can imply monetary policies to stabilise inflation rates but price level is expected to increase in 10 years. When the price level rises , each unit of currency buys fewer goods and services and as a consequence inflation reflects a reduction in the purchasing power per unit of money which is a loss of real value in the medium of exchange and unit of account within the economy. Supply law states that price and quantity supplied are directly related. That means if price level increases quantity supplied will increase. So as the price level is expected to increase with time, hence the production level will also increase over the next 10 years.

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