Suppose that this year's money supply is 500 dollars...

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

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

Key Concepts

Inflation

Inflation is the rate at which the general level of prices for goods and services is increasing over time. It affects the real value of money, and controlling inflation is a key objective of monetary policy. The relationship between changes in the money supply, the velocity of money, and real output helps determine inflation rates.

Monetary Policy

Monetary policy involves the use of the money supply and interest rate adjustments by a central bank to influence economic conditions, including output, employment, and the price level. Decision-making in monetary policy often utilizes relationships from the quantity theory of money to achieve targets like stable prices or a specific inflation rate.

Velocity of Money

Velocity of money measures the frequency at which one unit of currency is used to purchase domestically produced goods and services within a given time period. Understanding velocity is essential because it links monetary variables to real variables by showing how money supply translates into nominal GDP.

Price Level

The price level is a measure of the average prices of goods and services in an economy. It is typically used to determine inflation, which is the rate at which the general level of prices for goods and services is rising, and subsequently, how purchasing power is eroded over time.

Quantity Theory of Money

This theory relates the money supply, velocity of money (the rate at which money circulates in the economy), price level, and output. It is often expressed in the form MV = PY where M is the money supply, V is the velocity of money, P is the price level, and Y is real output. This equation is central to understanding how changes in the money supply can affect nominal GDP and inflation.

Nominal GDP and Real GDP

Nominal GDP is the total monetary value of goods and services produced in an economy measured at current prices, while real GDP is adjusted for inflation, reflecting the true quantity of production. Comparing these measures can provide insights into changes in both economic output and the price level.

Transcript

00:01 Okay, question one.

00:03 Suppose that this year's money supply is $500 billion.

00:08 Nominal gdp is $10 trillion, and real gdp is $5 trillion.

00:16 So apparently, this question is asking us about the quantity equation.

00:23 So we first write out the quantity equation is m times v equals to p.

00:32 Times why.

00:34 And we know that the money supply given by the question is 500 billion.

00:42 So it is 500 billion.

00:49 And what is the nominal gdp? so nominal gdp is actually just the price times the quantity.

00:58 So we know that this term equals to 10 trillion.

01:04 10 trillion.

01:06 And the real gdp is the y here is 5 trillion.

01:15 So with these information, we can answer question a.

01:19 Question a is saying, what is the price level? what is the velocity of money? so if we observe this equation, we know that the price level is just 10 trillion divided by 2 trillion, right? so we get this divided by 5 trillion so we get this p number here so the price level here p equals to two and what about the velocity of money so what about v so v is just 10 trillion divided by 500 billion so v equals to so 10 trillion is like 10 000 billion right so this divided by 500 is 20.

02:24 So the velocity of money is 20 in this question.

02:31 Okay, b, suppose that velocity is constant and the economy's output of goods and services rises by 5 % each year.

02:43 And what will happen to nominal gdp and the price level next year? year if the fed keeps the money supply constant.

02:51 Okay so in this question we still have to take a look at this equation and it is saying that what if the economy's output of goods and services rises by 5 % each year.

03:08 So why now increase by 5 % each year? so we have an increasing why here by 5%.

03:18 So i will just write it down as 5%.

03:23 What will happen to nominal gdp? so nominal gdp is the 10 trillion we have right here.

03:33 So say if fat keeps the money supply constant.

03:37 So we know that velocity is constant and the money supply is constant.

03:42 And this nominal gdp, this real gdp is going to rise by 5%.

03:52 So to make this left -hand side constant, we also have to make this right -hand side constant...