Question

Assume the money supply is $300, the velocity of money is 5, and the price level is 1. Using the quantity theory of money: a. Determine the level of real output. b. Determine the level of nominal output. c. Assuming velocity remains constant, what will happen if the money supply rises 20 percent? Real output would be $C, and real output would be $| d. If the government established price controls and also raised the money supply 35 percent, what would happen? Instructions: In order to receive full credit, you must make a selection for each option. For correct answer(s), click the box once to place a check mark. For incorrect answer(s), click the option twice to empty the box. Real output would decrease. The equation of exchange wouldn't hold. The price level would fall. The velocity of money would increase. Real output would increase. The velocity of money would decrease.

Answer 1

a.

As per the equation of money,

P × Real output = M × V

Where,

Price level = P

Money supply = M

Velocity = V

Therefore,

P × Real output = M × V

1 × Real output = 300 × 5

Real output = 1,500 (Answer)

b.

Nominal output = Real output × P

                           = 1,500 × 1

                           = 1,500 (Answer)

c.

Money supply increases 20%.

New M = 300 × (1 + 0.20)

            = 300 × 1.20

            = 360

P × Real output = New M × V

1 × Real output = 360 × 5

Real output = 1,800 (Answer)

Nominal output = Real output × P

                           = 1,800 × 1

                           = 1,800 (Answer)

d.

Money supply increases 35%.

New M = 300 × (1 + 0.35)

            = 300 × 1.35

            = 405

P × Real output = New M × V

1 × Real output = 405 × 5

Real output = 2,025

Nominal output = Real output × P

                           = 2,025 × 1

                           = 2,025

MCQ:

Answer: 5^th option; Real output would increase

This happens as per the above calculation.

Other options are not correct:

1^st option: it is increased only.

2^nd option: it is irrelevant here.

3^rd option: there is price control (said in the sum); therefore, no change there.

4^th option: as per the above calculation, V is unchanged.

6^th option: V is unchanged.