Question

Suppose that this year's money supply is $400 billion, nominal GDP is $12 trillion, and real GDP is $4 trillion. The price level is _______, and the velocity of money is ______. Suppose that velocity is constant and the economy's output of goods and services rises by 5 percent each year. If the Fed keeps the money supply constant, the price level will ______, and nominal GDP will ______. True or False: If the Fed wants to keep the price level stable instead, it should decrease the money supply by 5% next year. True False If the Fed wants an inflation rate of 9 percent instead, it should ______ the money supply by %. (Hint: The quantity equation can be rewritten as the following percentage change formula: (Percentage Change in M) + (Percentage Change in V) = (Percentage Change in P) + (Percentage Change in Y).

a. 3%, constant, decrease, increase
b. 4%, increasing, decrease, increase
c. 5%, constant, increase, decrease
d. 6%, decreasing, increase, decrease

Answer 1

The price level is 3 and the velocity of money is 30. If the Fed keeps the money supply constant, the price level will increase and nominal GDP will increase. If the Fed wants an inflation rate of 9 percent, it should increase the money supply by 4%.

Step-by-step explanation:

The price level is determined by dividing nominal GDP by real GDP. In this case, the price level is $12 trillion / $4 trillion = 3. Therefore, the price level is 3.

The velocity of money is the number of times a dollar is spent in a year. Since it is stated that velocity is constant, we can use the quantity equation to find velocity: Money Supply x Velocity = Nominal GDP => Velocity = Nominal GDP / Money Supply = $12 trillion / $400 billion = 30.

If the Fed keeps the money supply constant and the economy's output of goods and services rises by 5 percent each year, the price level will increase, and nominal GDP will increase as well. Therefore, the statement is false.

If the Fed wants an inflation rate of 9 percent, it should increase the money supply by 4%.