Suppose that this year’s money supply is $50 billion, nominal GDP is $1 trillion, and real GDP is...

Question

Suppose that this year’s money supply is $50 billion, nominal GDP is $1 trillion, and real GDP is $500 billion.
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?

Robert · Accepted Answer

Suppose that this year’s money supply is $50 billion, nominal GDP is $1 trillion, and 
real GDP is $500 billion.  
a. What is the price level? What is the velocity of money? 
Answer: 
Price level (P) = nominal GDP/real GDP = $1trillion/$500 billion = 2 
According to quantity theory of money: MV = PY 
So V = PY/M, where PY = Nominal GDP and M = Money supply 
V = $1 trillion/$50 billion = 20 
b. Suppose that velocity is constant and the economy’s output of goods and 
services rises by 5 percent each year.

Suppose that this year’s money supply is $50 billion, nominal GDP is $1 trillion, and real GDP is $500 billion. a. What is the price level? What is the velocity of money? b. Suppose that velocity is...

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