Concept explainers
Sub-part
A
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
Sub-Part
B
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.
Sub-Part
C
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.
Sub-Part
D
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.
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- 6. Monetary policy in the long run Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100. Suppose that the central bank in this economy is expanding the money supply by 4% each year. In order for the price level to be maintained at 100, real GDP must grow at an annual rate of (percentage?) if the velocity of money remains constant. Suppose the central bank enacts an unanticipated restrictive monetary policy. As a result, the supply of loanable funds (decreases/ Increase) , leading to a (rise/fall) in short-term interest rates. This in turn (reduces/raises) the opportunity cost of holding money. As people hold (Lower/ higher) money balances, the (velocity of money/ Price level/ aggregate output) will (rise/fall). True or false?: The shift in monetary policy exerts an impact on output and the general level of prices with a time lag. 6. Monetary policy in the long run Consider a hypothetical economy that produces at its…arrow_forward11. Inflation and unemployment Suppose that the government believes the economy is producing goods and services beyond its optimal level. The government therefore decides to decrease the quantity of money in the economy. This monetary policy_______ the economy's demand for goods and services, leading to________ product prices. In the short run, the change in prices induces firms to produce______ goods and services. This, in turn, leads to a_______ level of unemployment. In other words, the economy faces a trade-off between inflation and unemployment: Lower inflation leads to________ unemployment.arrow_forward(Monetary Control) Suppose the money supply is currently $500 billion and the Fed wishes to increase it by $100 billion. Given a required reserve ratio of 0.25, what should it do? If it decided to change the money supply by changing the required reserve ratio, what change should it make? Why may the Fed be reluctant to change the reserve requirement?arrow_forward
- 6. Monetary policy in the long run Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100. Suppose the real GDP of this economy grows at an annual rate of 2%. If the velocity of money is constant, the central bank can maintain the price level at 100 by means of which of the following? Expanding the money supply by 2% per year O Reducing the money supply by 2% per year les of O Keeping the money supply constant Suppose the central bank enacts an unanticipated restrictive monetary policy. As a result, the supply of loanable funds leading to a in short-term interest rates. The following graph shows the goods and services market of this economy at full employment. Assume that potential output remains constant. Adjust the graph to show the long-run effect of an unanticipated restrictive monetary policy on the goods and services market by dragging the 511 8/2/ aggregate demand (AD) curve, the short-run aggregate supply (AS) curve, or…arrow_forward5. Inflation and the quantity theory: Suppose velocity is constant, the growth rate of real GDP is 3% per year, and the growth rate of money is 5% per year. Calculate the long-run rate of inflation according to the quantity theory in each of the following cases: 1. What is the rate of inflation in this baseline case? 2. Suppose the growth rate of money rises to 10% per year. 3. Suppose the growth rate of money rises to 100% per year. 4. Back to the baseline case, suppose real GDP growth rises to 5% per year. 5. What if real GDP growth falls to 2% per year? 6. Return to the baseline case and suppose the velocity of money rises at 1% per year. What happens to inflation in this case? Why might velocity change in this fashion?arrow_forward14. The Opportunity Cost of Holding Assets as Money Suppose you have been told that the opportunity cost of holding wealth as money is determined by the interest rate, but you aren't sure whether this refers to the real interest rate or the nominal interest rate. Suppose the inflation rate is stable at 3%, and you currently have €1,000 in a non-interest-bearing bank account. Consider the decision of whether to hold wealth as money or as an interest-earning asset that pays a nominal rate of 6%. If you hold wealth as an interest-earning asset, you will have in wealth at the end of the year. If you hold the wealth as money, you will have in wealth at the end of the year. Holding wealth as an interest-earning asset therefore gives you more purchasing power than you would have if you held the wealth as money. This illustrates that the relevant interest rate for calculating opportunity cost of holding wealth as money is the interest rate. Now consider the decision of whether to spend your…arrow_forward
- 2. Money supply, money demand, and adjustment to monetary equilibrium The following table shows a money demand schedule, which is the quantity of money demanded at various price levels (PP). Fill in the Value of Money column in the following table. Now consider the relationship between the price level and the quantity of money that people demand. The lower the price level, the ____ (more/less) money the typical transaction requires, and the _____ (more/less) money people will wish to hold in the form of currency or demand deposits. Assume that the Fed initially fixes the quantity of money supplied at $2.5 billion. Use the orange line (square symbol) to plot the initial money supply (MS1MS1) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve. According to your graph, the equilibrium value of money is ______ , therefore the equilibrium price level is _____ Now, suppose that the Fed…arrow_forwardEconomics Suppose the difference between the transactions velocity and the income velocity of circulation of money in an economy is 5 and the money value of total transactions is 6 times the money value of aggregate income. If the quantity of money in circulation is 1000 currency units, then the money value of aggregate income in currency units is (a) 1000 (b) 1200 (c) 1500 (d) 1800 please write and explain in paperarrow_forward3. Changes in the money supply The following graph represents the money market in a hypothetical economy. As in the United States, this economy has a central bank called the Fed, but unlike in the United States, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 4% and a quantity of money equal to $0.4 trillion, as indicated by the grey star. (? 6.0 A New MS Curve Money Demand 5.0 4.5 New Equilibrium 4.0 3.6 3.0 2.5 Money Supply 2.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 MONEY (Trillions of dollars) Suppose the Fed announces that it is lowering its target interest rate by 75 basis points, or 0.75 percentage point. To do this, the Fed will use open- market operations to v the v money by v the public. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black…arrow_forward
- 6. The Fisher effect and the cost of unexpected inflation Suppose the nominal interest rate on savings accounts is 11% per year, and both actual and expected inflation are equal to 5%. Complete the first row of the table by filling in the expected real interest rate and the actual real interest rate before any change in the money supply. Nominal Interest Expected Actual Expected Real Interest Actual Real Interest Rate Inflation Inflation Rate Rate Time Period (Percent) (Percent) (Percent) (Percent) (Percent) Before increase in MS 11 Immediately after increase 11 5 6 in MS Now suppose the Fed unexpectedly increases the growth rate of the money supply, causing the inflation rate to rise unexpectedly from 5% to 6% per year. Complete the second row of the table by filling in the expected and actual real interest rates on savings accounts immediately after the increase in the money supply (MS). The unanticipated change in inflation arbitrarily benefits Now consider the long-run impact of…arrow_forward3. (Note: You should wait to tackle this question until after lecture on Thursday, November 19.) Suppose that the economy is initiallyin long-run equilibrium: output is at potential and, as a result, inflation is steady. Now, suppose there is a permanent upward shift of the Federal Reserve's reaction function. a. What does this upward shift in the reaction function imply about the Fed's long-run target for the rate of inflation? b. What does the change in the reaction function imply that the Fed will do to the nominal interest rate and to the real interest rate in the short run? Describe two things the Fed could do to bring about this change in interest rates. c. What will be the short-run effect of the shift in the reaction function on GDP? d. Describe briefly how GDP returns to its potential level. (Hint: What will happen to inflation after a while? How will the Federal Reserve respond to that?)arrow_forward3. Changes in the money supply The following graph represents the money market in a hypothetical economy. As in the United States, this economy has a central bank called the Fed, but unlike in the United States, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, as indicated by the grey star. (?) INTEREST RATE (Percent) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0 Money Demand 0.1 Money Supply 0.3 0.4 0.5 MONEY (Trillions of dollars) 0.2 0.6 0.7 0.8 New MS Curve New Equilibrium Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75 percentage point. To do this, the Fed will use open- market operations to the money by the public. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct…arrow_forward
Essentials of Economics (MindTap Course List)EconomicsISBN:9781337091992Author:N. Gregory MankiwPublisher:Cengage Learning
Brief Principles of Macroeconomics (MindTap Cours...EconomicsISBN:9781337091985Author:N. Gregory MankiwPublisher:Cengage Learning