Question

Suppose that the money supply is \(1 trillion and money velocity is 4. Then the equation of exchange would predict nominal GDP to be:

a. \)1 trillion.

b. \(4 trillion.

c. \)5 trillion.

d. $8 trillion

Short answer

The correct option is (b): $4 trillion.

Step-by-step solution

Explanation

The equation of exchange is given as MV = PQ.

Here, M is money supply, V is velocity, and PQ is the nominal GDP.

Substituting M with 1 trillion and V with 4, as given in the question, the nominal GDP is obtained as follows:

PQ = 1 x 4 = 4

Hence, the nominal GDP is $4 trillion.

Money Velocity is the number of times $1 is used to purchase 1 unit of a final good, meaning a money velocity of 4 implies that every $1 spent generates $4 of exchanges as the money supply moves around the economy.