S. Velocity and the quantity equation Consider a simple economy that produces on

Question

S. Velocity and the quantity equation Consider a simple economy that produces only pies. The following table contains information on the economy's money supply, velocity of money, price level, and output. For example, in 2010, the money supply was 360, the pnce of a pie was $4.50, and the economy produced 800 pies. Rin the missing values in the following table, rounding to the nearest cent when necessary. Quantity of Money (Dollars) 360 378 Price Level Quantity of Output Nominal GDP (Pies) 800 800 (Dollars) Year 2010 2011 Velocity of Money (Dollars) 4.50 10 The money supply grew at a rate of from 2010 to 2011. Since pie output did not change from 2010 to 2011 and the velocity of , the change in the money supply was reflected in changes in the price level. The inflation rate from 2010 to 2011 was Grade it Now

Explanation / Answer

Quantity equation is:

M x V = P x Y [Y: Real quantity of output, so (P x Y): Nominal GDP]

V = (P x Y) / M and

P = (M x V) / Y

(1)

(2)

Money supply grew at 5% [= (378/360) - 1 = 1.05 - 1 = 0.05 = 5%] from 2010 to 2011.

Since Velocity remains unchanged, the change in money supply was reflected totally (fully or only) in changes in price level.

Inflation rate from 2010 to 2011 was 5% [= (4.73/4.5) - 1 = 1.05 - 1 = 0.5 = 5%].

Year Money Supply (M) Velocity (V) Price level (P) Output (Y) Nominal GDP 2010 360 10 4.5 800 3600 2011 378 10 4.73 800 3780

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