Question

Using the quantity Theory of Money formula, suppose that in 2020: Money supply = $50 Billion;  Nominal GDP = $1.0 Trillion; and Real GDP = $500 Billion.

a). Calculate the Price Level (P) (2 marks) and Velocity of Circulation (V) (2 marks).  Show your calculations for a full mark.

b) Suppose the velocity of circulation is constant (the one you calculated in (a), and the economy’s output of goods and services increases by 5% annually. Calculate Nominal GDP (or what will happen to nominal GDP) (3 marks) and the Price Level (P) (3 marks) in 2021 if the Bank of Canada keeps the money supply in 2020 constant or the same?

c). Calculate or What level of money supply should the Bank of Canada set next year (2021) if it wants to keep the price level stable (hint: based on a 5% increase in real GDP). (5 marks)

Answer 1

- Quantity Theory of Money= P va (Nominal GDP) MV = a) Price Level = Mu=pa M = Money supply v=velocity of Money P= Price or inflation Level a= output Level or real GDP Pe= Nominal GDP P= Mu Q P= 550 * 1 Trillion 500 m billion Mv= Nominal GDP Price Level = 2 - velocity of Money- MV = v= pa pa M 1 Trillion 50 billion Velocity of Money = 6) Mv= pa In this it Mv is constant = 50820 = 1000 billion and output of goods and services increased by 5th then price Level (P) have to decrease by 5% and Nominal GOP will remain same because Nominal GOP (Px0) = Mv, in which MV is constant the nominal GDP have to be constant at 1000 billion

c) MU= pa. If a (Real GDP) increased by 5% and bank wants to keep prices (P) unchanged then bank have to increase the Money supply (M) by 5%. Only after increasing money supply by 5% then price will remain stable.
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