Suppose that this year's money supply is $400 billion, nominal GDP is $12 trillion, and real GDP is $4 trillion. The price level is , and the velocity of money is .
Suppose that velocity is constant and the economy's output of goods and services rises by 3 percent each year. Use this information to answer the questions that follow.
If the Fed keeps the money supply constant, the price level will , and nominal GDP will .
True
False
If the Fed wants to keep the price level stable instead, it should keep the money supply unchanged next year. True False If the Fed wants an inflation rate of 11 percent instead, it should the money supply by % . (Hint: The quantity equation can be rewritten as the following percentage change formula:

1. Price Level

= Nominal GDP/Real GDP

= 12 trillion/4 trillion

= $3

b. Velocity

= Price level * Real GDP/ Money supply

= 3 * 4/0.4

= 30

2. If the Fed keeps the money supply constant, the price level will Decrease , and nominal GDP will Remain the same .

The economy rose however money supply was kept constant. This means that prices could not rise and so had to decrease to cater for the increase in output. With lower prices but higher output, the Nominal GDP remained the same.

3. If the Fed wants to keep the price level stable instead, it should keep the money supply unchanged next year. TRUE

4. If the Fed wants an inflation rate of 11 percent instead, it should Increase the money supply by 14%.

(Percentage Change in Money supply) + (Percentage Change in V) = (Percentage Change in Price) + (Percentage Change in GDP).)

V is constant so is 0.

(Percentage Change in M) = (Percentage Change in P) + (Percentage Change in Y).)

= 11% + 3%

= 14%

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