Suppose that initially the money supply is $2 trillion, the price level equals 4

Question

Suppose that initially the money supply is $2 trillion, the price level equals 4, the real GDP is $6 trillion in base-year dollars, and income velocity of money is 12. Thern the money supply increases by $200 billion, while real GDP and income velocity of money remain unchanged a. According to the quantity theory of money and prices, calculate the new price level after the increase in money supply: b. Calculate the percentage increase in money supply. % C. Calculate the percentage change in the price level | % d. The percentage changes in the money supply is percentage changes in the price level.

Explanation / Answer

According to Quantity theory of Money

MV = PY

where M = Money supply

V= Velocity of Money Supply

P = Price level

Y = real GDP

a) According to quantity theory of money and prices, The new price level after the increase in money supply is 4.4

MV = PY

2.2 (12) = P(6)

P = 4.4

b) The percentage increase in momey supply is 10%

((2.2 - 2)/2)*100 = 10

c) The percentage increase in price level is 10%

((4.4-4)/4)*100 = 10

d) The percentage changes in the money supply is equal to percentage changes in price level.

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