Chapter 15, Problem 7P

Sub-part

A

To determine

the effect on the nominal GDP when the money supply increases by 5% and velocity remains unchanged.

Concept Introduction: As per the equation of exchange, M×V=P×Y, where M is the quantity of money, V is its velocity, Y is nominal GDP, and P is the price level. This equation explains that total spending is equal to total receipts. Thus, an increase in the quantity of money in the economy will lead to an increase in the price level, assuming the velocity and output level remains constant. Also, if there is an increase in the output level, it can lead to increase in demand for M, however, if the M remains constant, it will affect the velocity of money. The equation also states that the quantity of money spent equals the quantity of money used. The quantity theory of money explains the link in the variables. $V=\frac{P\times Y}{M}$ .

Sub-Part

B

To determine

the effect on the nominal GDP when the money supply decreases by 8% and velocity remains unchanged.

Concept Introduction: As per the equation of exchange, M×V=P×Y, where M is the quantity of money, V is its velocity, Y is nominal GDP, and P is the price level. This equation explains that total spending is equal to total receipts. Thus, an increase in the quantity of money in the economy will lead to an increase in the price level, assuming the velocity and output level remains constant. Also, if there is an increase in the output level, it can lead to increase in demand for M, however, if the M remains constant, it will affect the velocity of money. The equation also states that the quantity of money spent equals the quantity of money used. The quantity theory of money explains the link in the variables. $V=\frac{P\times Y}{M}$ .

Sub-Part

C

To determine

the effect on the nominal GDP when the money supply increases by 5% and velocity decreases by 5%.

Concept Introduction: As per the equation of exchange, M×V=P×Y, where M is the quantity of money, V is its velocity, Y is nominal GDP, and P is the price level. This equation explains that total spending is equal to total receipts. Thus, an increase in the quantity of money in the economy will lead to an increase in the price level, assuming the velocity and output level remains constant. Also, if there is an increase in the output level, it can lead to increase in demand for M, however, if the M remains constant, it will affect the velocity of money. The equation also states that the quantity of money spent equals the quantity of money used. The quantity theory of money explains the link in the variables. $V=\frac{P\times Y}{M}$ .

Sub-Part

D

To determine

the effect on the price level in the short run in each of the situations.

Concept Introduction: As per the equation of exchange, M×V=P×Y, where M is the quantity of money, V is its velocity, Y is nominal GDP, and P is the price level. This equation explains that total spending is equal to total receipts. Thus, an increase in the quantity of money in the economy will lead to an increase in the price level, assuming the velocity and output level remains constant. Also, if there is an increase in the output level, it can lead to increase in demand for M, however, if the M remains constant, it will affect the velocity of money. The equation also states that the quantity of money spent equals the quantity of money used. The quantity theory of money explains the link in the variables. $V=\frac{P\times Y}{M}$ .