Suppose that the money supply is $1 trillion and nominal GDP is $10 trillion. Wh

Question

Suppose that the money supply is $1 trillion and nominal GDP is $10 trillion. What is the velocity of money? For the next two questions, suppose that the velocity of money permanently increases by 25%. If the money supply is not changed in response, which of the following will occur in the short run? Real GDP, nominal GDP, and unemployment are all unchanged Prices are unchanged, nominal GDP is unchanged, real GDP rises Unemployment rises, prices rise, real GDP is unchanged Real GDP is unchanged, nominal GDP rises, prices rise Unemployment falls, real GDP rises, prices rise What will happen in the long run? Real GDP is unchanged, nominal GDP rises, prices rise Prices are unchanged, nominal GDP is unchanged, real GDP rises Unemployment falls, real GDP rises, prices rise Unemployment rises, prices rise, real GDP is unchanged Real GDP, nominal GDP, and unemployment are all unchanged

Explanation / Answer

1. The velocity of money meaures how rapidly the dollar bills changes hands in the economy. It is calculated as:

Velocity = Nominal GDP/Money supply.

Velocity = $10/$1 = $10 trillion.

2. Option D is correct.

In the short run, As the formula above is used, if the velocity increases, with no change in money supply, the nominal GDP would rise, and thereby increasing the prices of goods and services.

3. Option E is correct.

In the long run, with an increase in velocity, the price rise would balance out all the changes and equilibrium would be attained.

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