Question

Velocity.

a) The money supply is $600. The price level is 2 and Real GDP is 900. What is velocity?

b) The money supply grows 3%, velocity is growing 1%, real output is growing 2%. What is the inflation rate? Suppose that people are worried that future inflation will be very high, so that people don’t want to hold onto money since it will lose value, which makes velocity grow at a rate of 10%. If the money supply continues to grow at 3% and RGDP continues to grow at 2%, what would be the inflation rate now?

Answer 1

Answer : a) According to the quantity theory of money,

Money supply * Velocity = Price level * Real GDP

By putting given values in above formula we get,

600 * Velocity = 2 * 900

=> Velocity = (2 * 900) / 600

=> Velocity = 3

Therefore, here the velocity of money is 3.

b) 1) According to the quantity theory of money,

Growth rate of money supply + Growth rate of velocity = Inflation rate + Growth rate of real output

By putting given values in above formula we get,

3 + 1 = Inflation rate + 2

=> 4 - 2 = Inflation rate

=> Inflation rate = 2%

Therefore, here inflation rate is 2%.

2) According to the quantity theory of money,

Growth rate of money supply + Growth rate of velocity = Inflation rate + Growth rate of RGDP

By putting given values in above formula we get,

3 + 10 = Inflation rate + 2

=> 13 - 2 = Inflation rate

=> Inflation rate = 11%

Therefore, here inflation rate is 11%.