Question

Consider the data in Problem 16-10. Suppose that the money supply increases by $ 100 billion and real GDP and the income velocity remain unchanged.

a. According to the quantity theory of money and prices, what is the new equilibrium price level after full adjustment to the increase in the money supply?

b. What is the percentage increase in the money supply?

c. What is the percentage change in the price level?

d. How do the percentage changes in the money supply and price level compare?

Short answer

a. the new equilibrium price level after full adjustment to the increase in the money supply is$\$2.2$trillion

b. the percentage increase in the money supply is$10\%$

c. the percentage change in the price level is$10\%$

d. They both are equal

Step-by-step solution

introduction

The quantity theory of money expresses that there is an immediate connection between the money supply and the cost level. In the event that how much money supply in the economy builds, there is an expansion in the cost at a similar level consequently causing expansion.

explanation of part (a)

We know,

MV = PY

M = $\$1$trillion $+\$100$billion = $\$1.1$trillion

$\mathrm{Y}=\mathrm{\$}5\text{trillion,and}\mathrm{V}=\mathrm{\$}10\text{trillion}$

$$\begin{gathered} P=1.1\times \frac{10}{5} \\ P=2.2 \end{gathered}$$

the new equilibrium price level after full adjustment to the increase in the money supply is$\$2.2$trillion.

explanation of part (b)

Percentage increase in money supply = (money supply new value -money supply initial value)/initial value $\times 100$

$$\begin{gathered} \Rightarrow \frac{{\displaystyle 1.1-1)}}{1}\times 100 \\ =10\% \end{gathered}$$

explanation of part (c)

the percentage change in the price level

$$\begin{gathered} \Rightarrow \frac{{\displaystyle (2.2-2)}}{2}\times 100 \\ =10\% \end{gathered}$$

explanation of part (d) 

The rate change in cash supply is equivalent to the rate change in cost level. Henceforth an immediate connection between cash supply and the cost of labour and products is laid out, subsequently causing expansion. Accordingly, the amount hypothesis of cash is demonstrated.