Suppose that this year\'s money supply is $500 billion, nominal GDP is $10 trill

Question

Suppose that this year's money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5trillion.

a. What is the price level? What is the velocity of money?
b. Suppose that velocity is constant and the economy's output of goods and services rises by 5 percent each year. What will happen to nominal GDP and the price level next year if the Fed keeps the money supply constant?
c. What money supply should the Fed set next year if it wants to keep the price level stable?
d. What money supply should the Fed set next year if it wants inflation of 10 percent?

Explanation / Answer

a.
(500 billion)V = P(5 trillion)

First, we know that P(5 trillion) = 10 trillion. Therefore, P = 2

(500 billion)V = 2(5 trillion)
(divide both sides by 500 billion)
V = 20

b. Nominal GDP will stay the same, but the Price level will decrease.

c. If V is constant and we want P to also be constant. This means the only variables that can change are M and Y. So in this case, if Y (real GDP) goes up by 5%, M (the money supply) needs to increase by the same amount. 5% of the previously mentioned money supply of 500 billion is 25 billion, which gives us $525 billion.

d. Just add an addition 5% to get $550 billion.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.