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Chapter 4

The document outlines three tasks related to the Quantity Theory of Money and the Money Supply and Demand Framework. Task 1 asks about the impact on price level (P) when the money supply (M) increases by 10% while velocity (V) and real output (Y) remain constant. Task 2 involves analyzing how an increase in money supply affects equilibrium interest rates, investment, aggregate demand, and long-term price levels, while Task 3 requires calculating the necessary growth rate of money supply to achieve a targeted inflation rate of 2% amidst expected GDP growth of 3%.

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4 views1 page

Chapter 4

The document outlines three tasks related to the Quantity Theory of Money and the Money Supply and Demand Framework. Task 1 asks about the impact on price level (P) when the money supply (M) increases by 10% while velocity (V) and real output (Y) remain constant. Task 2 involves analyzing how an increase in money supply affects equilibrium interest rates, investment, aggregate demand, and long-term price levels, while Task 3 requires calculating the necessary growth rate of money supply to achieve a targeted inflation rate of 2% amidst expected GDP growth of 3%.

Uploaded by

thiendung26082006
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd

Task 1 — Using the Quantity Theory of Money

The Quantity Theory states: MxV=PxY


where:
 M: Money supply
 V: Velocity of money (assumed constant in the short run)
 P: Price level
 Y: Real output
Question:
If the central bank increases M by 10% while V and Y remain unchanged, what happens
to P?
Explain the intuition behind your answer.

Task 2 — Using the Money Supply and Demand Framework


The money market is defined by the equilibrium condition: MSr=Mdr
where:
 Ms: Money supply (set by the central bank)
 Mdr= L(i,Y): real money demand depends negatively on interest rate i and
positively on income Y.
Question:
Draw and explain how an increase in money supply (Ms) affects:
1. The equilibrium interest rate i.
2. Investment and aggregate demand in the short run.
3. The price level P in the long run as the economy returns to potential output.

Task 3 — Application Question


Suppose the central bank wants to target an inflation rate of 2% while GDP is expected to
grow by 3% and the velocity of money is stable.
Question:
Using the Quantity Theory, what should the growth rate of the money supply be to
achieve this target?
Explain your reasoning clearly.

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