Question

Assume that you are one of six thousand people who live on the small island of Tap. This island is small and can only produce a maximum of six thousand bags of corn a year (ignore technological advances in corn production that are occurring elsewhere in the world). The six thousand bags of corn produced are just enough for the residents since each resident only earns enough to buy one bag of corn a year (a pity since the Tapese really love corn!). The currency on Tap is the US dollar. Now suppose that the government of Tap injects more US dollars into the economy, and the result is that person now ends up having twice the amount of US dollars as he or she did before. Make a logical prediction about prices of corn in the economy, and explain what principle of economics is illustrated in this scenario. Develop a response that includes examples and evidence to support your ideas, and which clearly communicates the required message to your audience. Organize your response in a clear and logical manner as appropriate for the genre of writing. Use well-structured sentences, audience-appropriate language, and correct conventions of standard American English. Need this essay as soon as possible please!

Answer 1

SOLUTION ;-

Quantity Theory of Money (QTM) propounded by economist Henry Thornton in 1802. The theory states that 'more money equals more inflation and an increase in money supply does not necessarily mean an increase in economic output.  
There exists a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. Accordingly, if the amount of money in an economy doubles, price levels also double. The consumer therefore pays twice as much for the same amount of the good or service.'

, if the government of Tap injects more US dollars into the economy, and the result is that each person now ends up having twice the amount of US dollars as he or she did before, and this extra money does not result in any extra production of corn (since we are ignoring technological advances in corn production that are occurring elsewhere in the world), twice the amount of dollars would chase six thousand bags of corn a year

The logical implication being the price of each bag of corn would double to $2 (an inflation rate of 100%). This represents demand-pull inflation (higher demand for the same amount of goods due to doubling of money supply)

The QTM holds that money is like any other commodity. Hence, an increase in its supply decreases marginal value (the buying capacity of each unit of currency).

So an increase in money supply causes prices to rise (inflation) to compensate for the decrease in money's marginal value

The problem associated with such a scenario is reflected in statistical computations. Earlier, the economy of Tap produced six thousand bags of corn a year priced at $1 each.

. So the Gross Domestic Product or GDP was

6000*1=$6000

. Now it produces the same six thousand bags of corn a year but the excess money in the economy has hiked the price to $2.

So the GDP at current prices becomes

6000*2=$12000

Note that it appears the nominal size of the economy has doubled although the number of goods produced is exactly the same. To avoid this, GDP needs to be calculated at constant prices (base year prices) for accurate measurement.

. Real GDP in the new scenario works out to $6000 which is the same

QTM posits quantity of money determines the value of money

Therefore, economists belonging to the monetarist school believe a rapid increase in money supply leads to a rapid increase in inflation. Even if there is an increase in economic output, money growth that surpasses the growth of economic output results in inflation, as there is too much money behind too little production of goods and services. In order to curb inflation, money growth must fall below the growth in economic output.

Hence monetarists believe that money supply should be kept within an acceptable bandwidth, so that levels of inflation can be controlled. For the short term, most monetarists agree that an increase in money supply can offer the requisite boost to a faltering economy. In the long term, however, the effects of monetary policy continue to remain debatable.