Question

Consider the following table:

Year	Quantity of Money (billions of $)	Velocity	Real GDP (billions of 2009 $)	GDP Deflator
2006	$1,369	10.274	$14,717
2009	$1,684	8.650		1.002
2012	$2,434	6.696	$15,384

Fill in the missing data, using the quantity equation of money.

Why might velocity change in this way?

Calculate the average inflation rate between 2006 and 2009 and between 2009 and 2012.

If velocity had remained at the 2006 level, what would the deflator have been in 2009 and 2012, assuming real GDP and money are as in the table?

Answer 1

Fill in the missing data, using the quantity equation of money.

According to quantity equation P x Y = M x V

2006 has GDP deflator x 14717 = 1369 x 10.274

GDP deflator = 1369 x 10.274/14717 = 0.956

2009 has 1.002 x Real GDP = 1684 x 8.650

Real GDP = 14537.52

2012 has GDP deflator x 15384 = 2434 x 6.696

GDP deflator = 2434 x 6.696 / 15384 = 1.0594

Why might velocity change in this way?

Velocity measures how many time currency circulates. With the use of credit cards, debit cards and electronic money, currency circulation may fall. This will reduce velocity of money with time

Calculate the average inflation rate between 2006 and 2009 and between 2009 and 2012.

Average inflation between 2006-09= (1.002 – 0.956)*100/0.956 = 4.8%

Average inflation between 2009-12 = (1.0594 – 1.002)*100/1.002 = 5.7%

If velocity had remained at the 2006 level, what would the deflator have been in 2009 and 2012, assuming real GDP and money are as in the table?

In case velocity is fixed at 2006 level

2009 has GDP deflator x 14537.52= 1684 x 10.274

GDP deflator = 1684 x 10.274*100/14537.52 = 1.1901

2012 has GDP deflator x 15384 = 2434 x 10.274

GDP deflator = 2434 x 10.274/ 15384 = 1.626