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Economics Tutorial: Inflation and Policy Analysis

The document is a tutorial for an economics course, focusing on various economic concepts such as inflation, interest rates, and the Quantity Theory of Money. It includes questions on the implications of government policies on lenders, calculations related to money supply and price levels, and an assessment of Milton Friedman's claim regarding inflation. Additionally, it addresses the challenges of rising inflation with falling output and outlines monetary policy tools used by the RBI to manage inflation.

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13 views2 pages

Economics Tutorial: Inflation and Policy Analysis

The document is a tutorial for an economics course, focusing on various economic concepts such as inflation, interest rates, and the Quantity Theory of Money. It includes questions on the implications of government policies on lenders, calculations related to money supply and price levels, and an assessment of Milton Friedman's claim regarding inflation. Additionally, it addresses the challenges of rising inflation with falling output and outlines monetary policy tools used by the RBI to manage inflation.

Uploaded by

sakshamsucks96
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

HS-203: Introduction to Economics

Tutorial 5
Questions

September 5, 2025

1. A government is facing rising inflation and large public debt. To ease the burden of
debt servicing, it imposes a ceiling on nominal interest rates at 7%, even though lenders
expect inflation to average 8% in the coming years.
(a) Calculate the real return to lenders under this policy.
(b) From the perspective of lenders, savers, and financial institutions, explain how this
policy might change their behavior in the short run.
(c) Discuss the potential long-term effects on financial intermediation and economic
growth if such interest rate caps persist.
2. (a) The Quantity Theory of Money is expressed as
MV = PY
where:
• M = Money supply
• V = Velocity of money
• P = Price level
• Y = Real output
Suppose in an economy:
M = 1000 billion, V = 4, Y = 2000 billion units.
(a) Calculate the price level P .
(b) If money supply increases by 20% while V and Y remain unchanged, find the
new price level.
(b) The Quantity Theory of Money assumes that velocity of money is constant in the
short run. Critically evaluate this assumption. Under what circumstances might
velocity change, and how would that affect the relationship between money supply
and price level?

1
3. Milton Friedman argued that “inflation is always and everywhere a monetary phe-
nomenon.” Using the Quantity Theory of Money (MV = PY), assess this claim in the
following scenarios:
• Case 1 (2000–2010): Country X’s money supply grew at 12% annually, while
real GDP grew at 5% per year. Velocity remained roughly constant, and inflation
averaged close to 7%.
• Case 2 (2020–21): The same country experienced a one-year inflation spike of
10% due to a global oil shock, even though money supply growth remained mod-
erate.
Question: In which case does Friedman’s claim fit better, and why? Under what assump-
tions does his statement hold strictly true?
4. What is the economic phenomenon called when an economy experiences rising inflation
alongside falling output? Explain how supply shock will lead to this phenomenon and
discuss the challenges it creates for monetary policy.
5. List three most important tools of monetary policy that the RBI employs to control high
inflation due to higher aggregate demand and explain their mechanism briefly?

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