Question

Following the above balance sheet, suppose the assets of the First National Bank increases by 4%, so it becomes $520 from $500. Then which of the following must be true?

Select one:

Deposits of the Bank increases by $25.

Capital increases by 100%

Reserves doubles

Debt decreases

Which of the following is known as classical dichotomy?

Select one:

a. Monetary policy affects nominal variables but not real variables

b. Monetary policy affects real variables but not nominal variables

c. both a and b

d. neither a nor b

Which of the following is true about the neutrality of money proposed by classical economist?

Select one:

An increase in money supply affects the price level.

An increase in money supply affects Nominal wage

An increase in money supply does not affect real GDP.

All of the above

Suppose a country produces only one good: car. Let in year 2011, it produces 1000 units of car and the price of each car is $20. If the money supply in the economy is $2000.00, then which of the following is true about its nominal GDP and velocity of money?

Select one:

GDP is $2000 and velocity of money is 100

GDP is $20,000 and velocity of money is 10

GDP is $20, 0000 and velocity of money is 100

GDP is $20, 0000 and velocity of money is 1

Answer 1

Solution:

1. As the asset side has increased, it must be due to increase in one of the components of assets. Deposits and capital are on the liability side, so these are eliminated. Also, debt is on asset side but its decrease means decrease in assets. Thus, the only correct option is reserve doubling, as reserve is on the asset side, and it increases, increasing the asset.

Thus, correct option is (C) Reserve doubles.

2. Classical dichotomy separates real and nominal variables, that is nominal variables change do not impact/influence the real variables. Also, the changes in money instruments, like money supply also changes only the nominal variables and not the real variables.

Thus, the correct option is (A) Monetary policy affects nominal variables but not real variables.

3. Money neutrality indicates that change in money stock affects only the nominal variables, and not the real variables. Thus, increase in money supply will affect the price level and wages, but not real GDP.

Thus, the correct option is (D) All of the above.

4. The quantity theory of money states that: Money supply*velocity = price*real GDP

M*V = P*Y

Then, we are given P = $20, Y = 1000 units, M = $2000

Also, nominal GDP = price*real GDP

Nominal GDP = 20*1000 = $20,000

So, V = P*Y/M or Nominal GDP/M

V = 20000/2000 = 10

So, the correct option is (B) GDP is $20,000 and velocity of money is 10.