Question

Suppose that this year's money supply is $600 billion, nominal GDP is $15 trillion, and reel GDP is $3 trillion.
The price level is_______ and the velocity of money is__________
Suppose that velocity is constant and the economy's output of goods and services rises by 3 percent each year. Use this information to answer the questions follow.

If the Fed keeps the money supply constant, the price level Will ________ , and nominal GDP Will___________

If the Fed wants to keep the price level stable instead, it should increase the money supply by 3% next year.
a. True
b. False

If the Fed wants an inflation rate of 11 percent instead, it should_________ the money supply by________

Answer 1

Answer:

1. Price level:

Nominal GDP = Price * Real GDP

15 trillion = Price * 3 trillion

Price = 15/3

Price = $5

Velocity:

Money supply * Velocity = Price level * Real GDP

0.6 trillion * Velocity = 5 * 3 trillion

Velocity = 15 trillion / 0.6

=25

_________________________________________________________

2. Suppose that velocity is constant and the economy's output of goods and services rises by 3 percent each year:

If the Fed keeps the money supply constant, the price level will DECREASE BY 3% , and nominal GDP will REMAIN THE SAME.

Money supply constant:

% change in money supply + %change in velocity = %change in price + %change in real GDP

%change in price = % change in money supply + %change in velocity - %change in real GDP

= 0 + 0 - 3%

= -3%

3. If the Fed wants to keep the price level stable instead, it should increase the money supply by 3% next year. TRUE.

_________________________________________________________

Suppose that velocity is constant and the economy's output of goods and services rises by 3 percent each year:

4. If the Fed wants an inflation rate of 11 percent instead, it should INCREASE the money supply by 14%.

Price level change = 11%

%change in price = % change in money supply + %change in velocity - %change in real GDP

11% = % change in money supply + 0% - 3%

% change in money supply = 11% + 3%

= 14%

Answer 2

The price level will be $5 and the velocity of money will be 25.

Based on the information given, the price level will be:

= Nominal GDP / Real GDP

= $15 trillion / $3 trillion

= $5

The velocity of money will be:

= (5 × 3 trillion) / 0.6 trillion

= 15 trillion / 0.6 trillion.

= 25

It should be noted that when the Fed keeps the money supply constant, then the price level will reduce by 3% and the nominal GDP will remain the same.

Therefore, if the Fed wants to keep the price level stable, it should increase the money supply by 3% next year.

If the Fed wants an inflation rate of 11 percent instead, it should increase the money supply by 14%. This was calculated as:

Change in money supply = 11% + 3% = 14%

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