1.
Determine the size of the M1 money supply using the following
information.
Currency plus Traveler’s checks $25 million
Negotiable CDs $10 million
Demand deposits $13 million
Other checkable deposits $12 million
Solution:
M1 = Currency + Traveler’s checks + Demand deposits + Other checkable deposits
M1 = $25 million + $0 million + $13 million + $12 million
= $50 million
6 (a)A country’s gross domestic product (GDP) is $20 billion, and its money supply (MS) is
$5 billion.
What is the country’s velocity of money (VM)?
Solution:
Velocity of Money (VM) = GDP / Money Supply
VM = $20 billion / $5 billion = 4 times
6 (b) If the MS stays at the same level next year while the velocity
of money “turns over” 4.5 times, what would be the level of GDP?
Solution:
New GDP = Velocity of Money × Money Supply
New GDP = 4.5 × $5 billion = $22.5 billion
6 (c) Assume that the VM will turn over 4 times next year. If the
country wants a GDP of $22 billion at the end of next year, what will
have to be the size of the money supply? What percentage increase
in the MS will be necessary to achieve the target GDP?
Solution:
Required Money Supply = GDP / Velocity of Money
Required Money Supply = $22 billion / 4 = $5.5 billion
Percentage increase in MS = (New MS - Old MS) / Old MS × 100
Percentage increase = ($5.5 billion - $5 billion) / $5 billion × 100 = 10%
9. (a) If the M1 money supply increases by 10 percent and the M1 velocity of money does
not change, what is the expected value of the GDP for next year?
Answer:
The GDP equation based on the monetarist view is:
GDP=MS×VM
Where,
MS= Money Supply
VM= Velocity of Money
MS increased by 10%,
MSnew= MSold × 1.10
VM remains unchanged
VMnew=VMold
Expected GDP for next year,
GDPnew= MSnew × VMold
= MSold × 1.10× VMold
b. If real output does not change, what is the expected average
price for the products? What percentage change in the price level
would occur?
Economist View,
RO × PL = GDP
Where,
RO= Real Output
PL= Price Level
PLnew= GDPNEW/ ROOLD
So, based on part (a), if the GDP increases by 10%:
PLnew=1.10×PLold
C. If the M2 money supply decreases by 10 percent, and the M2 velocity of money does not
change, what is the expected value of GDP next year?
Given that the M2 money supply decreases by 10%, and the velocity of money remains constant,
the expected GDP will follow the same relationship as before:
GDPNEW = MSNEW × VMNEW
Since the money supply decreases by 10%:
MSNEW = MSOLD ×0.90
Therefore, the expected GDP will decrease by 10%.
d. If the price level does not change, what is the expected real output in units or
products?
If the price level stays constant, then the change in GDP must be entirely due to a change in real
output. Thus, real output will change in proportion to the money supply change. Since the GDP
decreased by 10%, the real output will also decrease by 10%.
PLNEW= 0.90× PLOLD
[Link] Problem The following problem requires a basic
knowledge about probabilities and the calculation of expected
values. The problem is more easily solved using Excel
spreadsheet software.
12.
Scenario A B C D E Metric
Probability .10 .20 .40 .2 .1 Percent
0 0
Velocity of money 2.5 3.0 3. 4.2 Turnover
1.75 5 5
Real output 375 45 50 55 62 Units in
0 0 0 5 thousands
Price level 75 90 10 11 12 Dollars
0 0 5
[Link] the dollar amount of the money supply under each
scenario or outcome.
SOLUTION:
Applying Formula for Each Scenario:
MS=(PL×RO)/VM
Scenario A:
MSA=(75×375)/1.75
=28,125/1.75
=16,071.43
Scenario B:
MSB=(90×450)/2.5
=40,500/2.5
=16,200
Scenario C:
MSC=(100×500)/3.0
=50,000/3.0
=16,666.67
Scenario D:
MSD=(110×550)/3.5
=60,500/3.5
=17,285.71
Scenario E:
MSE=(125×625)/4.25
=78,125/4.25
=18,411.76
b. Calculatethe expected value of the money supply, taking into
consideration each scenario and its probability of occurrence.
Solution:
Expected Money Supply
E(MS)=(PA×MSA)+(PB×MSB)+(PC×MSC)+(PD×MSD)+(PE×MSE)
Where P represents the probability of each scenario.
Substituting the values:
E(MS)=(0.10×16,071.43)+(0.20×16,200)+(0.40×16,666.67)+(0.20×17,285.71)+(0.10×18,411.76
)
Calculating each term:
E(MS)=1,607.14+3,240+6,666.67+3,457.14+1,841.18
=16,812.13
So, the expected value of the money supply (MS) is 16,812.13.