Question

In: Economics

Using money creation to pay for government spending Consider Kharkeez, a hypothetical country that produces only...

Using money creation to pay for government spending

Consider Kharkeez, a hypothetical country that produces only burgers. In 2017, a burger is priced at $2.00.

Complete the first row of the table with the quantity of burgers that can be bought with $900.

Hint: In this problem, assume it is not possible to buy a fraction of a burger, and always round down to the nearest whole burger. For example, if your calculations result in 1.5 burgers, the answer should be 1 burger.

Year

Price of a Burger

Burgers Bought with $900

(Dollars)

(Quantity)
2017 2.00

?
2018

?

?

Suppose the government of Kharkeez cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 40% by 2018.

Assuming monetary neutrality holds, complete the second row of the table with the new price of a burger and the new quantity of burgers that can be bought with $900 in 2018.

The impact of the government's decision to raise revenue by printing money on the value of money is known as the (velocity of money, fisher effect, inflation tax, classical dichotomy).

Solutions

Expert Solution

In 2017, the burger price is $2

Money available to buy burger = $900

Burger bought with $900 in 2017 = ($900 / $2)

=> Burger bought with $900 in 2017 = 450

---------------------------------------------

The money supply increase by 40% in 2018.

Accoridng to money neutrality, increase in money supply will increase the price level by same percentage. So, 40% increase in money supply in 2018 will increase the price level by 40%.

The price of burger in 2018 = $2 * (1 + 40%)

=> the price of burger in 2018 = $2 (1 + 0.40)

=> The price of burger in 2018 = $2 (1.4)

=> The price of burger in 2018 = $2.8

-----

Burger bought with $900 in 2018 = ($900 / $2.8)

=> Burger bought with $900 in 2018 = 321.42

=> Burger bought with $900 in 2018 = 321 (round down to nearest whole number)

---------------------------------------------------------------------

Year Price of burger ($) Burgers bought with $900 (Quantity)
2017 2 450
2018 2.8 321

The impact of the government's decision to raise revenue by printing money on the value of money is known as the inflation tax

Rahul Sunny answered 1 year ago
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