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11 Dec 2019

Suppose that potential GDP and the velocity of circulation are constant. What is the change in the price level in the long run if the quantity of money increases by 3 percent a year?

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13 Dec 2019
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Related questions

Consider an economy where the production function is given by Y = K^(1/2)L^(1/2). The level of capital in the economy equals 400, and the number of employed workers is 225. Suppose the quantity of money in the economy equals 200, and the velocity of money circulation is constant and equals 5. Suppose initially the economy is in the long-run equilibrium.

1. Use the quantity theory of money to determine the aggregate demand in the economy.

2. Determine the equilibrium output and the price level in period 0.

3. Suppose in period 1 the central bank decreases money supply by 50. What will happen to output in the short-run?

4. Is monetary policy neutral in the short-run?

5. What will be the equilibrium price level and output after prices adjust to the shock?

6. Is monetary policy neutral in the long-run?

Suppose that this year’s money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5 trillion.

a. What is the price level? What is the velocity of money?

b. Suppose that velocity is constant and the economy’s output of goods and services rises by 5 percent each year. What will happen to nominal GDP and the price level next year if the Fed keeps the money supply constant?

c. What money supply should the Fed set next year if it wants to keep the price level stable?

d. What money supply should the Fed set next year if it wants inflation of 10 percent?

During the depression, the U.S central bank, the Federal Reserve, enacted policies that increased the money supply by 6%.

1) What happens to the level of output and the price level in the shor- run and in the long-run?

2) Assume that the velocity is constant, what are the percentage change of output and price level in the short run and long run? (Hint: use quantity theory of money).

3) What happens to unemployment in the short-run and long-run? (Hint: Okun's law can be summaries in the following equation: in unemployment rate =

% in real GDP )

4) What happens to the real interest rate in the short-run and long-run? (Hint: Use the model of real interest rate in Chapter 3, to see what happens when output changes)

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