Answer
a) The velocity of money is 20, and the price level is 2.
b) The price level falls by 5%, and nominal GDP stays the same.
c) If the Fed increases the money supply by 5%, then the price level will stay stable. (The nominal GDP increases 5%, so the money supply needs to increase by this same amount to keep prices stable.)
d) The money supply will need to increase by 15%.
Work Step by Step
money supply is 500 billion
nominal GDP is 10 trillion
real GDP is 5 trillion
a)
velocity = nominal GDP/money supply
$V = 10000/500$ billion/billion
$V = 20$
GDP deflator * real GDP = nominal GDP
$ d * 5 = 10$ trillion
$d = 2$
b)
money supply * velocity = real GDP * GDP deflator
$ M * V = P * Y$
M and V hold constant, so if the real GDP increases, the GDP deflator decreases by the same amount the real GDP increases.
d)
$M * V = P * Y$
P increases by 5%
Y increases by 10%
M * V increases by 15%
