Question 1

Consider the quantity equation MV = PY. Assume that the money market is in equilibrium, where the money supply equals the demand for money, MS = MD = M. Assume also that the velocity of money is constant. In a graph with P on the vertical axis and Y on the horizontal axis, draw the relationship Y(P) implied by the quantity theory. How could this curve be interpreted? How does it change when MS increases?

Accepted Answer

The answer of Consider the quantity equation MV = PY....

Question 2

Suppose we interpret the quantity theory as a money demand equation. The quantity theory of money equation can be transformed into a growth rate equation: ÄM/M + ÄV/V = ÄP/P + ÄY/Y. If the velocity of money and real GDP are constant, calculate the elasticity of the demand for money with respect to the price level.

Accepted Answer

The answer of Suppose we interpret the quantity theory as...

Question 3

Refer to the following:
a. The central bank of the Republic of Moldova needs to determine by how much to increase the money supply next year, if they estimate an increase in the overall economic activity (real GDP) of 2.5 percent and have a target inflation rate of 4 percent. The velocity of money has been observed to be constant over the past many years. If you were a consultant to the government, what would your advice be?
b. Next year, the National Bank of Moldova wishes to reduce inflation to 2 percent, and estimates an increase in real GDP by 1.5 percent. What should be the change in the money supply?

Accepted Answer

The answer of Refer to the following:
a. The central bank...

Question 4

This problem compares the effect of a tax on interest earnings over a number of years, when interest is compounded annually. Suppose you purchase $1000 worth of mutual funds paying an average of 5 percent per year.
a) How much is your interest after 30 years if there was no tax on interest?
b) How much is your interest after 30 years if there is a 20 percent tax on interest earnings?

Accepted Answer

The answer of This problem compares the effect of a...

Question 5

In a graph having the price level P on the vertical axis and the quantity of money M on the horizontal axis and considering V and Y independent on the price level or the quantity of money demanded, draw the Md - P curve that is implied by the quantity equation. Now, replace the price level in your graph with the value of money on the vertical axis and redraw the money demand curve. What do you observe?

Accepted Answer

The answer of In a graph having the price level...

Question 6

Suppose Geoff considers borrowing $100 from Tracey at a 10 percent interest rate. They both think that a 6 percent real interest rate would be fair.
a) What was the inflation rate they both expected?
b) If the inflation rate turned out to be 7 percent, how much was the real interest rate? Who gained and who lost from this transaction, and how much because of unexpected inflation?
c) If there was an interest tax of 30 percent, what is the after-tax real interest rate, with the inflation rate of 8 percent?

Accepted Answer

The answer of Suppose Geoff considers borrowing $100 from Tracey...

Question 7

In this problem we try to establish a link between the quantity equation, MdV = PY, and the money demand-money supply diagram (Md is the quantity of money demanded). In a graph having the price level P on the vertical axis and the quantity of money M on the horizontal axis and considering V and Y independent on the price level or the quantity of money demanded, draw the Md - P curve that is implied by the quantity equation.

Accepted Answer

The answer of In this problem we try to establish...

Question 8

Use a money supply and demand diagram to answer the following problem: Everything else being the same, what is the effect of an increase in interest rates on the price level? Discuss the process of adjustment to the new equilibrium.

Accepted Answer

The answer of Use a money supply and demand diagram...

Question 9

Suppose Geoff considers borrowing $100 from Tracey. They both think that a 4 percent real interest rate would be fair, but they are aware of a 30 percent interest income tax. Therefore, they think of the fair 4 percent real interest rate as an after-tax rate. How much should Geoff pay to Tracey in interest, such that the after-tax real interest rate would be 4 percent, if they expect inflation to be 6 percent? What if the expected inflation was 8 percent? How does this affect Geoff's incentive to borrow?

Accepted Answer

The answer of Suppose Geoff considers borrowing $100 from Tracey....

Question 10

Inflation distorts relative prices. What does this mean, and why does it impose a cost on society?

Accepted Answer

The answer of Inflation distorts relative prices. What does this...

Question 11

Use a money supply and demand diagram to answer the following problem: "The introduction of automated teller machines was equivalent to an increase in money supply." Discuss this assertion.

Accepted Answer

The answer of Use a money supply and demand diagram...

Question 12

In a graph having the price level P on the vertical axis and the quantity of money M on the horizontal axis and considering V and Y independent on the price level or the quantity of money demanded, draw the Md - P curve that is implied by the quantity equation. Show how the P?2-Md curve changes when Y changes.

Accepted Answer

The answer of In a graph having the price level...

Question 13

Explain how inflation affects savings.

Accepted Answer

The answer of Explain how inflation affects savings....

Question 14

Let ÄX denote a small change in the variable X. Starting from the quantity equation MV = PY, show that the following relation between percentage changes holds: ÄM/M + ÄV/V = ÄP/P + ÄY/Y. (Note: It should be emphasized that this relationship holds for small changes, say less than 5 percent. The larger the changes, the less precise are the results derived from this relationship.)

Accepted Answer

The answer of Let ÄX denote a small change in...

Question 15

The velocity of money in the small Republic of Sloagia is always the same. Last year, the money supply was $2 billion and real GDP was $5 billion. This year, the money supply increased by 6 percent, real GDP by 4 percent, and nominal GDP is $6.5 billion.
a) Calculate the velocity of money and the price levels in the two years, and then calculate the inflation rate.
b) Calculate the inflation rate using the formula ÄM/M + ÄV/V = ÄP/P + ÄY/Y, where the Greek letter Ä represents a change and the ratio ÄM/M × 100 is the percentage change (or the rate of change) in M. Compare this result with the result you obtained in part
a. Why could there be some difference?

Accepted Answer

The answer of The velocity of money in the small...

Quiz 11: Money Growth and Inflation

Use a money supply and demand diagram to answer the following problem: Everything else being the same, what is the effect of an increase in interest rates on the price level? Discuss the process of adjustment to the new equilibrium.

Inflation distorts relative prices. What does this mean, and why does it impose a cost on society?

Use a money supply and demand diagram to answer the following problem: "The introduction of automated teller machines was equivalent to an increase in money supply." Discuss this assertion.

Explain how inflation affects savings.