iPad 3:27 PM courses.aplia.com Attempts Average: 12 5. Using money creation to p
ID: 1106640 • Letter: I
Question
iPad 3:27 PM courses.aplia.com Attempts Average: 12 5. Using money creation to pay for government spending Consider Snackistan, a hypothetical country that produces only cakes. In 2016, a cake is priced at $4.00 Complete the first row of the table with the quantity of cakes that can be bought with $700 Note: In this problem, assume it is not possible to buy a fraction of a cake, and always round down to the nearest whole cake. Price of a Cake Cakes Bought with $700 (Quantity) Year(Dollars) 2016 2017 4.00 Suppose the government of Snackistan cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 20% by 2017 Assuming monetary neutrality holds, complete the second row of the table with the new price of a cake and the new quantity of cakes that can be bought with $700 in 2017, The impact of the government's decision to raise revenue by printing money on the value of money is known as the Grade It Now Save & Continue Continue without saving Copyright Notices Terms of Use Security Notice
Explanation / Answer
In 2016, price of cake = $4.
If a person has total $700 of income, the maximum number og cakes he can afford is 700/4 = 175. Thus in 2016, 175 cakes can be bought.
Now, since the government is unable to meet its debt obligations due to insufficient tax revenue, it prints more money. As a result, nominal money supply increases by 20% by 2017. Given that money is neutral, it means that any increase in the nominal money supply has no real impacts on the economy. That is, the real money balances, i.e. M/P remain unchanged.This will happen only when Prices also rise by 20% by 2017.
So in 2017, cake will be priced at:
$4+ 0.2*4 = $4.8
As a result, with $700, we can buy only 700/4.8 = 146 cakes.
Thus the value of money has fallen due to government's decision to print money. This impact on value of money is known as 'inflation tax'.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.