Question

5.

Quantity Theory of Money

(a) Spell out the quantity theory of money equation

(b) If the velocity of money is constant, and real GDP grows at 2.5%, what happens to the growth of nominal income?

(c) Suppose there is an economy with only one good; corns. Money supply in the economy is $100. The price of corns is $2 per cob. This year the economy produced 200 corns. Calculate the income velocity of money. Give appropriate unit.

Answer 1

a)

Quantity Theory of Money Equation:

MV = PY

M = Quantity of money

V = Velocity of Money

P = Price

Y = Output level

b)

Nominal income depends on the money supply, if there is no change in output level and money supply is increased. it will cause rise in nominal income. But here real output rises, so nominal income is also likely to rise.

c)

MV = PY

100V = 2*200

100V = 400

V = 4