Question

According to the quantity theory, the size of the money determines the price level. Assume the following: - The rate of circulation of the money (): 14 - The money supply in year 1 (: 600 billion - Money supply in year 2 (636 billion - GDP in year 1 (: 4200 billion - GDP in year 2 (: 4343 billion Calculate inflation between year 1 and year 2!

Answer 1

Answer

According to quantity theory of money:

MV = PY where V = rate of circulation of money(Velocity)

M = Money Supply , P = Price level and Y = GDP

YEAR 1

MV = PY

=> 600 billion*14 = P*4200 billion

=> P = 2

YEAR 2

MV = PY

=> 636 billion*14 = P*4343 billion

=> P = 2.050

Inflation rate = % change in Price level = ((Price level in Year 2 - Price level in Year 1)/Price level in Year 1)*100

= ((2.050 - 2)/2)*100

= 2.5%

Hence, inflation rate between year 1 and year 2 = 2.5%