Suppose that this year’s money supply is $600 billion, nominal GDP is $15 trilli

Question

Suppose that this year’s money supply is $600 billion, nominal GDP is $15 trillion, and price level is 3. (6 pts.)

a) Compute the real GDP and the velocity of money? (2 pt.)

b) Suppose that % change of velocity is 1% and the economy’s output of goods and services (real GDP) rises by 3% each year. What is the growth rate of the nominal GDP and the price level next year if the Fed increases the money supply by 5.5%? (2 pt.)

c) What money supply should the Fed set next year if it wants to keep the price level stable? (1 pt.)

d) What money supply should the Fed set next year if it wants inflations of 2%? (1 pt

Explanation / Answer

(a) As we know

MV = PY

where M = money supply, V velocity of Money, P = price level, Y = real GDP

As, Nominal GDP = MV

Then Velocity of Money (V) = $15 / $0.6 = 25.

Now Real GDP (Y) = (0.6 * 25) / 3 = $5 trillion.

(b) Now Velocity of money (V) = 25 * 101% = 25.25

Real GDP (Y) = 5 * 103% = $5.15 trillon

Money supply(M) = 0.6 * 105.5% = 0.633

Now nominal GDP = 0.633 * 25.25 = 15.98325

Growth in nominal GDP = (15.98325 - 15) = .98325

% growth in nominal GDP = (0.98325 / 15)*100 = 6.555%

Now Price level (P) = (0.633 * 25.25) / 5.15 = 3.10354

% growth in price level = [(3.10354 - 3) / 3] * 100 = 3.45%.

(c) M/P=Y/V
=> 0.633 * X = 3 * 5.15 / 25.25
=> X = 3 * 5.15 / (25.25 * 0.633)
=> X = 0.97
M = -3%

Money Supply should be $582 billion.

(d) M/P=Y/V
=>0.633 * X / 3 * 1.02)= 5.15 / 25.25
=> X = 3 * 5.15 * 1.02 / (25.25 * 0.633)
=> X = 0.99
M= -1%

Money Supply should be $594 billion.

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