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

Question

4. Velocity and the quantity equation Consider a simple economy that produces only pens. The following table contains information on the economy's money supply, velocity of money, price level, and output. For example, in 2016, the money supply was $400, the price of a pen was $5.00, and the economy produced 800 pens. Fill in the missing values in the following table, selecting the answers closest to the values you calculate. Quantity of Output Quantity of Money (Dollars) 400 404 Price Level Nominal GDP Velocity of Money Dollars) Year 2016 2017 (Dollars) 4,000.00 4,040.00 ? 10) 5.00 5.05Y 800 10 800 The money supply grew at a rate of 0.5%from 2016 to 2017. Since pen output did not change from 2016 to 2017 and the velocity of money dec ease , the change in the money supply was reflected entirely ? in changes in the price level. The inflation rate from 2016 to 2017 was 101%

Explanation / Answer

Table is correctly filled.

According to Quantity theory of money:

MV = PY

M is the quantity of money

V is the velocity of money

P is the price level

Y is the real GDP

In 2016: 400 x V = 5 x 800

V = 10

Nominal GDP = Price level x quantity of output = 5 x 800 = 4000

In 2017:

404 x 10 = P x 800

P = 5.05

Nominal GDP = 5.05 x 800 = 4040

a) Money supply grew = (404 - 400)/400 x 100 = 4/400 x 100 = 1%

b) remains same

c) entirely

d) Inflation rate = (4040 - 4000)/4000 x 100 = 40/4000 x 100 = 1%

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