What will happen to real GDP given a $30 billion increase in the money supply under...
What will happen to real GDP given a $30 billion increase in the money supply under the following assumptions?
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Each $5 billion increase in the money supply reduces the rate of interest by 0.50 percentage point.
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Each 1 percentage point decline in interest rates stimulates $100 billion worth of new investment.
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The spending multiplier is 2.5.
Assume that the aggregate supply curve is so flat that the price level does not rise noticeably when aggregate demand increases.
Homework Answers
Money supply is increased by 30 billion. This will decrease the rate of interest by (30/5)*0.5 = 3%.
The decrease in the rate of interest by 3% will increase the investment by (3/1)*100 = 300 billion.
Spending multiplier is 2.5 and investment is increased by 300 billion. This indicates that the real GDP will increase by 300 x 2.5 = 750 billion.
Therefore real GDP will increase by 750 billion when money supply is increased by 30 billion.
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