I have NO idea how to do this. Suppose that an economy\'s money supply is $1688

Question

I have NO idea how to do this. Suppose that an economy's money supply is $1688 billion, and its real GDP is $12973 billion, and its nominal GDP is $14242 billion. a) Solve for the index for the general price level in this economy. -Is this how you do it: GDP Deflator = Nominal/Real * 100 = 1.097 b) Calculate the velocity for the money (V) for this economy. -Is this how you do it: Price Index * Real GDP / Money Supply = 843.78 c) Suppose that the velocity is constant and the output rises by 2% per year. What will happen to the nominal GDP and the price level next year if the central bank keeps the price level stable? d) What level of money supply should the central bank set next year if it wants to keep the price level stable? e) What level of money supply should the central bank set next year if it wants an inflation rate of 4%? f) What growth rate should the central bank set for the money supply if they want inflation to be steady at 2% per year?

Explanation / Answer

Suppose that an economy's money supply is $1688 billion, and its real GDP is $12973 billion, and its nominal GDP is $14242 billion. a) Solve for the index for the general price level in this economy. -Is this how you do it: GDP Deflator = Nominal/Real * 100 = 1.097 Nominal GDP = P x Y = 14242 and Y = real GDP = $12973, so P = (P x Y )/Y = $14242 /$12973 = 1.097 Because M x V = P x Y, then V = (P x Y )/M = $12973, x 1.097 /$1688 = 8.43 ===================================== . b) Calculate the velocity for the money (V) for this economy. -Is this how you do it: Price Index * Real GDP / Money Supply = 843.78 If M and V are unchanged and Y rises by 8.43%, then because M x V = P x Y, P must fall by 8.43%. As a result, nominal GDP is unchanged. ========================================= c) Suppose that the velocity is constant and the output rises by 2% per year. What will happen to the nominal GDP and the price level next year if the central bank keeps the price level stable? To keep the price level stable, the Fed must increase the money supply by2%, matching the increase in real GDP. Then, because velocity is unchanged, the price level will be stable. ========================================================

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