Consider Snackistan, a hypothetical country that produces only cakes. In 2016, a

Question

Consider Snackistan, a hypothetical country that produces only cakes. In 2016, a cake is priced at $2.00. Complete the first row of the table with the quantity of cakes that can be bought with $700 Hint: In this problem, assume it is not possible to buy a fraction of a cake, and always round down to the nearest whole cake. For example, if your calculations result in 1.5 cakes, the answer should be 1 cake. Year 2016 2017 Price of a Cake (Dollars) 2.00 Cakes Bought with $700 (Quantity) Suppose the government of Snackistan cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 40% by 2017. Assuming monetary neutrality holds, complete the second row of the table with the new price of a cake and the new quantity of cakes that can be bought with 5700 in 2017 The impact of the government's decision to raise revenue by printing money on the value of money is known as the Continue without saving

Explanation / Answer

Ans.

A) In year 2016 when price of cake is $2 then quantity of cake bought with $700 is 700 / 2 = 350.

price of cake quantity bought

2016 $2 350

B) In year 2017 money supply increase by 40% and money neutrality holds that means with change in money supply it will have no effect on number of cakes being produced.Since monay supply has increased that means price of cake will increase. So, 40% on $2 is 0.8.Such that price has incresed from $2 to 2 + 0.8 = $2.8.

thus price in 2017 for a cake is $2.8 which means purchasing power of money has decreased.So the quantity of cake purchased with $700 is 700 / 2.8 = 250

price of cake quantity bought

2017 $2.8 250

C) The impact of goverenment decision to raise revenue by printing money on value of money is called as inflation tax.Government prints money to pay its debt such that value of money declines.In this case as well 350 cakes could be bought with $700 before printing more money but after rise in money supply with $700 , cakes bought are 250.Such that government taxes taxes on who holds the money ,decreasing the purchasing power.

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