Question

ECON 1A-Week Name: In Class Activity - Money Growth & Inflation This assignment is taken from the PPT slides' Active Learning Activities for ch. 12. If you have questions, check out the slides or the Canvas discussion. This participation activity is due on Canvas. Consider an economy with one good, corn. The economy has enough labor, capital, and land to produce Y-800 bushels of corn. In 2018, MS = $2000, P = $5/bushel. 1. Compute nominal GDP and velocity in 2018. 2. In 2019 the central bank increased the MS by 5%, to $2100. a. Compute the 2019 values of nominal GDP and P b. Compute the inflation rate for 2018-2019 c. Suppose technological progress causes Y to increase to 824 in 2019. Compute 2018-2019 inflation rate with the new value of Y

Answer 1

(1) According to the quantity theory of money.

M*V = P*Y

Where M is the money supply.

V is the velocity

P is the Price level.

Y is the real GDP.

M= $2000,

P = $5 / bushel

Y =800 bushel of corn.

V = ?

M*V = P*Y

$2000 * V = $5 * 800

$2000 * V = $4000

V = $4000 / $2000

V = 2

Velocity is 2.

Nominal GDP = P * Y

Nominal GDP = $5 * 800

Nominal GDP = $4000.

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(2)

(a) M * V = P * Y

In terms of growth

% change in M + % change in V = % change in P + % change in Y

The quantity theory of money assumes that V and Y remain constant.

Therefore, the % change in V and % change in Y will be zero.

% change in M + % change in V = % change in P + % change in Y

% change in M = 5

5 + 0 = % change in P + 0

% change in P = 5

There is 5% increase in the price.

New price = $5 (1 + 0.05)

New price = $5 (1.05)

New price = $5.25

Nominal GDP = P * Y

Nominal GDP = $5.25 * 800

Nominal GDP = $4200.

(b) Inflation rate = [(new price - price) / price]* 100

Inflation rate = [(5.25 - 5) / 5] * 100

Inflation rate = 5%

(c) Now technological progress increases Y to 824

% change in Y = [(824 - 800)/800]*100

% change in Y = [24 / 800]*100

% change in Y = 3%

We have, % change in M + % change in V = % change in P + % change in Y

5 + 0 = % change in P + 3

% change in P = 5 - 3

% change in P = 2

There is 2% increase in the price level.

Hence, the inflation rate is 2%