Suppose there is only one good: umbrella. The economy has enough resources to produce a real...

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Suppose there is only one good: umbrella. The economy has enough resources to produce a real GDP of 1,500 umbrellas. Vis cons

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Answer 1

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(a)

According to quantity theory of money :

M_SV = PY

where Y = Real GDP , P = price level. Thus Nominal GDP = Real GDP*Price level = PY

=> M_SV = PY = Nominal GDP

Formula % change in (A*B) = % change in A + % change in B

=> % change in (M_SV) = % change in (Nominal GDP)

=> % change in (M_S) + % change in V = % change in Nominal GDP

As V is constant => % change in V = 0 and % change in (M_S) = 10%(Given)

=> 10% + 0 = % change in (Nominal GDP)

=> % change in (Nominal GDP) = 10%

Hence Nominal GDP will increase by 10%.

Initially Nominal GDP(in 2016) = PY = 10*1500 = 15000.

So, New level of Nominal GDP(in 2017) = 15000 + 10% of 1500 = 15150

It is given that he has resources to produce 1500 worth of real GDP and thus Real GDP = 1500 umbrellas are constant

% change in (nominal GDP) = % change in (PY) = % change in (P) + % change in Y

=> 10% = % change in P + 0

=> Inflation rate = % change in P = 10%

Hence Inflation rate = 10%.

(b)

According to quantity theory of money :

M_SV = PY

where Y = Real GDP , P = price level. Thus Nominal GDP = Real GDP*Price level = PY

=> M_SV = PY

Formula % change in (A*B) = % change in A + % change in B

=> % change in (M_SV) = % change in (PY)

=> % change in (M_S) + % change in V = % change in (P) + % change in Y

It is given that % change in M = 10%, V is constant => % change in V = 0%, Y increases from 1500 to 1650 => % change in Y = ((1650 - 1500)/1500)*100 = 10%. Thus % change in Y = 10%

=> % change in (M_S) + % change in V = % change in (P) + % change in Y

=> 10% + 0% = % change in P + 10%

=> Inflation rate = % change in P = 0%

Hence, 2016 - 2017 Inflation rate = 0%.

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