Suppose that in November the money supply was $200 billion, velocity was 10 and

Question

Suppose that in November the money supply was $200 billion, velocity was 10 and real GDP was $400 billion. What is the price level?

Suppose you believe in the quantity theory of money (monetarism). In the next month, December, you know that the money supply will increase to $300 billion. What would be your prediction of the price level if there were no changes in the resources in the economy (Human Capital, Physical Capital, etc.)?

In December, suppose the money supply does increase to $300 billion and there were no changes in resources in the economy. However, the price level did not change from November. What must have velocity been in December to ensure prices did not change given the increase in the money supply? Please give the numeric value of velocity in December.

Explanation / Answer

MV = PQ.

M is the money supply; V is velocity -- the number of times per year the average dollar is spent; P is prices of goods and services; and Q is quantity of goods and services.

Suppose that in November the money supply was $200 billion, velocity was 10 and real GDP was $400 billion. What is the price level?

Solution - P =200*10/400 =$5

Suppose you believe in the quantity theory of money (monetarism). In the next month, December, you know that the money supply will increase to $300 billion. What would be your prediction of the price level if there were no changes in the resources in the economy (Human Capital, Physical Capital, etc.)?

Solution -

P= 300*10/400=$7.5

In December, suppose the money supply does increase to $300 billion and there were no changes in resources in the economy. However, the price level did not change from November. What must have velocity been in December to ensure prices did not change given the increase in the money supply? Please give the numeric value of velocity in December.

P= $5

M = 300 billion

V = 5*400/300 = 6.67

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