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. Then 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

A. MV = PY

M = 2 trillion = 2000 billion

New M = 2000+200 = 2200 billion

V = 12, P =?, Y = 6000 billion

P = MV / Y = 2200*12/6000 = 4.4

B. Percentage increase in money supply =( 200 billion / 2000 billion) *100 = 10%

C. % change in price = (4.4-4)/4)*100 = 10%

D. % change in money supply (10%) equals % change in price (10%).

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