Suppose that this year's money supply is $500 billion, nominal gdp is $10 trillion, and real gdp is $5 trillion. a. what is the price level? what is the velocity of money? b. suppose that velocity is constant and the economy's output of goods and services rises by 5 percent each year. what will happen to nominal gdp and the price level next year if the fed keeps the money supply constant? c. what money supply should the fed set next year if it wants to keep the price level stable? d. what money supply should the fed set next year if it wants inflation of 10 percent?

a. The price level is $2.

The velocity of money is 20.

b. The nominal GDP will remain same, price level will decrease by 5%.

c. The money supply should be $525 billion.

d. The money supply should be $575 billion.

Explanation:

Suppose that this year's money supply is $500 billion, the nominal GDP is $10 trillion, and the real GDP is $5 trillion.

a. The real GDP =

$5 trillion =

P =

Price level =$2

The Fisher equation is,

MV = PY  

here, M = money supply, P = Price level, V = velocity of money, Y = real GDP

0.5V = 10  

V = 20  

So the velocity of money is 20.  

b.  If the velocity is constant and the money supply is kept constant. The 5% increase in output level will cause the price level to decrease by 5% and the nominal GDP will remain the same. This is because the supply will increase by 5% but demand will remain the same.  

c. The fed should increase the money supply by 5%. This will cause the demand to increase by 5%. While the supply is increasing by 5% as well. In this situation, the price level will remain the same.  

The money supply should be  

=

= $525 billion  

d. If the fed wants inflation of 10 percent or the price level to increase by 10 percent, it should increase the money supply by 15%. This will increase demand by 15%. The supply is increasing by 5% only. The price level will thus increase by 15% - 5% = 10%.

The money supply should be  

=

= $575 billion  

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