All Blue cells are required to have input, I am struggling with this question. 1

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All Blue cells are required to have input, I am struggling with this question.

130-1. Suppose that this year's money supply is $500 billion, nominal GDP is $10 trillion, 2 and real GDP is $5 trillion. a. What is the level? What is the velocity of mon 4 Price Level GDP Real GDP Look up formula for Price level 6 Veloci Price Level RGDP Look up formula for Velocity 8 b. Suppose that velocity is constant and the economy's output of goods and services 9rises by 5 percent cach year. What will happen to nominal GDP and the price level next 10 11 Price Level 12 13 Velocit 14 15 c. What money supply should the Fed set next year if it wants to keep the price level 16 17 Veloci 18 19 d. What money supply should the Fed set next vear if it wants inflation of 10 percent? 20 21 Before 22 After 23 24 25 26 27 28 29 30 31 32 if the Fed GDP Real GDP Look up formula for Price level Price Level RGDP Look up formula for Veloci stable? Price Level RGDP Use the Equation Below to compl lete this one With slight algebraic rearrangement, this equation can be rewritten as This equation states that the quantity of money (M) times the velocity of money (V) equals the price of output (P) times the amount of output (Y). It is called the quantity equation because it relates the quantity of money (M) to the nominal value of output (P x Y). The quantity equation shows that an increase in the quantity of money in an economy must be reflected in one of the other three variables: The price level must rise, the quantity of output must rise, or the velocity of money must fall. 34 35 36 37 38 39 40 In many cases, it turns out that the velocity of money is relatively stable. For example, Figure 3 shows nominal GDP, the quantity of money (as measured by M2), and the velocity of money for the U.S. economy since 1960. During this period, the money supply and nominal GDP both increased more than thirtyfold. By contrast, the velocity of money, although not exactly constant, has not changed

Explanation / Answer

Solution :

Money supply = $500 billion, nominal GDP = $10 trillion, real GDP, Y = $5 trillion

a) Real GDP = Nominal GDP/P, P is the price level

So, P = Nominal GDP/Real GDP = $10 trillion/$5 trillion = $2.

(In excel you may write : Under GDP $10 trillion, under Real GDP $5 trillion, so formula for price level, P (= B5/C5))

Using the given formula : M*V = P*Y,

Since, we have M = $500 billion, Y = $5 trillion (or $5,000 billion), P = $2

V = P*Y/M = 2*5000/500 = 20

(In excel you may fill the values as given, under P write formula as mentioned above, i.e, =B5/C5, under Velocity write : =B7*C7/D7)

For rest of the parts, I don't provide excel typing, but the answers and method to reach the answers. The excel coding is pretty much the same: just notice which term's formula is required and what all determinants it uses.

b) If real GDP has risen by 5%, new RGDP or Y = $5 trillion*(1 + 0.05) = $5.25 trillion

With constant velocity and money supply, M*V = 500*20 = $10,000 billion or $10 trillion

M*V = Y*P

P = M*V/Y = 10/5.25 = $1.905 approx

Nominal GDP = Real GDP*P = 5.25*1.09 = $5.7225 trillion (approx)

For the next 2 parts, please verify whether with change in output each year (as mentioned in part (b)), for both corresponding parts do the question refer to next year everytime, or parts (c) and (d) are just changes of part (b)? The answers I have provided are for parts (c) and (d) as changes in (b), please notify in case it is otherwise, as the answers will vary hugely then.

c) If Fed wants to keep price level stable, i.e, keep P = $2, Y = $5.25 trillion, V = 20

M = P*Y/V = 2*5.25/20 =$0.525 trillion or $525 billion. So, fed should set money supply at $525 billion.

d) If Fed wants inflation of 10%, so price level rises by 10%. New P = 2*(1 + 0.1) = $2.2

Now, V = 20, P = 2.2, Y = $5.25 trillion

M = P*Y/V = 2.2*5.25/20 = $0.5775 trillion or $577.5 billion. New money supply that Fed should set = $577.5 billion.

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