Assume the money supply is $700, the velocity of money is 4, and the price level

Question

Assume the money supply is $700, the velocity of money is 4, and the price level is $4. Using the quantity theory of money:

a. Determine the level of real output.

    $_______

b. Determine the level of nominal output.

    $_______

c. Assuming velocity remains constant, what will happen if the money supply rises 20 percent?

    Nominal output would be $_______, and real output would be $_______.

d. If the government established price controls and also raised the money supply 10 percent, what would happen?

(You may select more than one answer. Click the box with a check mark for correct answers and click to empty the box for the wrong answers.)

The velocity of money might decrease. Real output will increase in a monopolistic economy. The equation of exchange wouldn't hold. Shortages would result in a perfectly competitive economy.

Explanation / Answer

Part a

MV = PY

where,

M = Money Supply

V = Velocity of money

P = Price Level

Y = Real GDP

Using the values given in the question,

$700 * 4 = $4 * Real GDP

Real GDP = $2,800/$4 = $700

Part b

Nominal GDP = Price level * Real GDP = $4 * $700 = $2,800

Part c

If Money Supply rises by 20%

Increase in Money Supply = 20% * $700 = $ 140

New Money Supply = $700 + $140 = $ 840

MV = PY

$840 * 4 = $4 * Real GDP

Real GDP = $840

Nominal GDP = $4 * $840 = $3,360

Part d

Shortages would result in a perfectly competitive economy.

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