Consider a simple economy that produces only pizzas. The following table contain
ID: 1196742 • Letter: C
Question
Consider a simple economy that produces only pizzas. The following table contains information on the economy's money supply, velocity of money, price level, and real GDP.
Year: 2014 Quantity of money ($) Velocity of Money: 3 Price level($) Real GDP (pizzas):240 Nominal GDP ($):1200
Year: 2015 Quantity of money ($): Velocity of Money: 3 Price level($): Real GDP (pizzas):240 Nominal GDP ($):
A. Based on the quantity equation and the information given in the table, compute the price level and the money supply in 2014.
B. Suppose the money supply increases by 10% from 2014 to 2015. The real GDP (output) stays unchanged. Compute the money supply, the nominal GDP, and the price level in 2015.
C. Compute the inflation rate from 2014 to 2015.
Explanation / Answer
A. Price level in 2014 = Nominal GDP / Real GDP = 1200 / 240 = 5
As per quantity theory of money : Ms * V = P * Y
therefore Ms = (5 * 240) / 3 = 400
B. Now as Ms increased by 10% therefore Ms in 2015 = 400 + 10% of 400 = 440
Price level in 2015 = (440 * 3) / 240 = 5.5
Nominal GDP = 5.5 * 240 = 1320
C. Price level increased from 5 to 5.5 from 2014 to 2015, therefor inflation rate = [(5.5 - 5) / 5] * 100 = 10%