¡Descarga Promblem set 7 - Money Growth and Inflation y más Ejercicios en PDF de Macroeconomía solo en Docsity! Problem set 7 Money growth and inflation 1. 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? Price level Nominal GDP = P x Y P = Nominal GDP / Y = 10,000/5,000 = 2 So price level is 2. Velocity of money V = (P × Y )/M = $10,000/$500 = 20. So velocity of money is 20. b) Suppose that velocity is constant and the economy’s output of goods and services rises by 5 per cent each year. What will happen to nominal GDP and the price level next year if the central bank keeps the money supply constant? If M and V are unchanged and Y rises by 5%, then taking into account the formula M × V = P × Y, price level must fall by 5%. As a result, nominal GDP is unchanged. c) What money supply should the central bank set next year if it wants to keep the price level stable? To keep the price level stable, the central bank must increase the money supply by 5%, matching the increase in real GDP. Then, because velocity is unchanged, the price level will be stable. d) What money supply should the central bank set next year if it wants inflation of 10 per cent? If inflation is 10%, it will need to increase the money supply 15%. Thus M × V will rise 15%, causing P × Y to rise 15%, with a 10% increase in prices and a 5% rise in real GDP 2. Suppose that changes in bank regulations expand the availability of credit cards, so that people need to hold less cash. a. How does this event affect the demand for money? People will need less cash and the demand for money will decrease. b. If the central bank does not respond to this event, what will happen to the price level? We would have a higher supply of money than demand and this will cause inflation which means that the prices will increase c. If the central bank wants to keep the price level stable, what should it do? The central bank may decrease the supply of money to put in correlation with the demand of money. 3. It is often suggested that central banks should try to achieve 0 inflation. If we assume that velocity is constant, does this zero inflation goal require that the rate of money growth equal zero? If yes, explain why. If no, explain what the rate of money growth should be equal. According to the formula: (M x V = P x Y ). With same velocity, but decline the inflation rate to zero should goal require the money growth rate to equal the growth rate of output, as the theory of money says. 4. Let’s consider the effects of inflation in an economy composed only for two people: Michael, a bean farmer, and Dorothy, a rice farmer. Michael and Dorothy both always consume equal amounts of rice and beans. In year 2018 the price of beans was 1 and the price of rice was 3. a. Suppose that in 2019 the price of beans was 2 and the price of rice was 6. What was inflation? Was Michael better off, worse off or unaffected by the changes in prices? What about Dorothy? Inflation = 100%, Michael and Dorothy are unaffected by the changes in prices. b. Now suppose that in 2019 the price of beans was 2 and the price of rice was 4. What was inflation? Was Michael better off, worse off or unaffected by the changes in prices? What about Dorothy? Inflation = 50%, Michael is better off and Dorothy is worse off. c. Now suppose that in 2019 the price of beans was 2 and the price of rice was 1.5 . What was inflation? Was Michael better off, worse off or unaffected by the changes in prices? What about Dorothy? -12.5 %, Michael is worse off and Dorothy is better off. d. What matters more to Michael and Dorothy the overall inflation rate or the relative price of rice and beans? The relative prices of both goods matters more than the inflation rate because when the price of the product which an individual produce is greater than the inflation rate, the person will be better off and similarly, when the price of the product which an individual produce is smaller than the inflation rate, the person will be worse off. 5. If the tax rate is 40% compute the before-tax real interest rate and the after-tax real interest rate in each of the following cases. a. The nominal interest rate is 10% and inflation rate 5% Before-tax real interest rate = Nominal interest rate – inflation rate Before-tax real interest rate = 10 - 5 = 5% After-tax Nominal interest = Nominal interest rate - Tax rate After-tax Nominal interest = 10 - (0.4 x 10) = 6% After-tax real interest = Nominal interest rate after tax - Inflation rate After-tax real interest = 6 - 5 = 1%.
