Question

5. Using money creation to pay for government spending Consider Kharkeez, a hypothetical country that produces only burgers. In 2017, a burger is priced at $4.00. Complete the first row of the table with the quantity of burgers that can be bought with $700. Hint: In this problem, assume it is not possible to buy a fraction of a burger, and always round down to the nearest whole burger. For example, if your calculations result in 1.5 burgers, the answer should be 1 burger. Year 2017 Price of a Burger Burgers Bought with $700 (Dollars) (Quantity) 4.00 2018 Suppose the government of Kharkeez cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 20% by 2018. Assuming monetary neutrality holds, complete the second row of the table with the new price of a burger and the new quantity of burgers that can be bought with $700 in 2018. The impact of the government's decision to raise revenue by printing money on the value of money is known as the

Answer 1

In 2017, if price of burgers is 4 and total spending is 700, quantity of burgers = spending/price = 700/4 = 175

Now, since the neutrality of money holds, an increase in money supply leads only to an increase in prices of the same proportion.

Price of burger in 2018 = (1+inflation)*price 2017

= 1.2*4 = 4.8

Thus, quantiity 2018 = 700/4.8 = 145.8 = 146 burgers

The impact of printing money on the value of the money is known as Inflation.