(a)
The velocity of money.
(a)
Explanation of Solution
An expression for the velocity of money can be derived using the quantity equation.
The quantity equation can be re-written as follows:
Here, M is the quantity of money and P is the price of one unit of output. Therefore,
Therefore, the velocity of money is
This velocity of money has positive relation with nominal interest rate because when nominal interest rate is high then, people will hold less money. As a result, the money that people hold are used more often and velocity increases.
Velocity of money: Income velocity of money describes about the number of times a dollar bill enters someone's income in a given period of time.
(b)
The velocity of money.
(b)
Explanation of Solution
The value of velocity of money can be calculated using the expression of velocity, which is found in part (a).
Here, ‘i’ is the nominal rate, if it is 4 percent, then the value of velocity of money can be calculated as follows:
Therefore, if the nominal rate is 4 percent then, the velocity of money is 10 percent.
Velocity of money: Income velocity of money describes about the number of times a dollar bill enters someone's income in a given period of time.
(c)
The price level (P).
(c)
Explanation of Solution
The value of price level can be calculated using Equation (1).
Re-write the equation as follows:
Now, substitute the respective vales into Equation (2).
Therefore, the price level is $12.
(d)
The fisher effect on the nominal interest rate.
(d)
Explanation of Solution
The fisher effect describes that 1 percent increase in the rate of inflation turn causes a 1 percent increase in the nominal interest rate. This one-to-one relationship is called the Fisher effect. Therefore, an increase of expected inflation rate by 5% also causes a 5% increase in the nominal interest rate where the initial nominal interest rate is 4 percent, therefore, according to Fisher effect, the new nominal interest rate is 9%
Nominal interest rate: Nominal interest rate is the interest rate that the bank pays.
(e)
The new velocity of money.
(e)
Explanation of Solution
The velocity of money can be calculated using the expression of velocity which is found in part (a).
Here, ‘i’ is the nominal rate and the new value of nominal interest rate is 9 percent. Therefore, the value of velocity of money can be calculated as follows:
Therefore, if the nominal rate is 9 percent then, the velocity of money is 15 percent.
Nominal interest rate: Nominal interest rate is the interest rate that the bank pays.
Velocity of money: Income velocity of money describes about the number of times a dollar bill enters someone's income in a given period of time.
(f)
The new price level (P).
(f)
Explanation of Solution
The value of price level can be calculated using Equation (2) described in part (c).
Substitute the respective vales into Equation (2).
Therefore, the new price level is $18. Here, when the nominal interest rate increases from 4 percent to 9 percent the price level also increases from $12 to $18 because the increase in nominal interest rate also increases the
(g)
The supply of money.
(g)
Explanation of Solution
The value of price level (P) is keep as $12, the nominal interest rate (i) is $9, and the output (Y) is 1,000.
Now, the supply of money can be calculated using Equation (2) as described in part (c).
Therefore, the new money supply is $
Want to see more full solutions like this?
- Provide the equation for the velocity of money in terms of Price level (P), output (Y), and the amount of money in the economy (M) a) Explain what will happen to velocity if P increases and why. b) Explain what will happen to velocity if Y increases and why. c) Explain what will happen to velocity if M increases and why.arrow_forwardSuppose the money demand function is ▪ Md/P = 1000+ 0.2Y - 1000 (r + πе). (a) Calculate velocity if Y = 2000, r = .06, and Te = .04. (b) If the money supply (Ms) is 2600, what is the price level? "(c) Now suppose the real interest rate rises to 0.11, but and Ms are unchanged. What happens to velocity, and the price level? So if the hominal interest rate were to rise from 0.10 to 0.15 over the course of a year, with Y remaining at 2000, what would the inflation rate be?arrow_forwardSuppose that C= $900, I- S300, G- $200, NX - S100, and that the money supply is equal to $300. Based upon these assumptions, velocity is equal to component of spending If consumption and velocity both rise beyond their initial levels, then it follows that another necessarily fall. a. 5; must b. 5; does not c. 3; must d. 3; does notarrow_forward
- 1) Assume that velocity (how many times a dollar is used in a given period) stays the same, and that GDP does not change. If the money supply doubles, what will happen to the general price level in the economy according to the quantity equation? A) The inflation rate will double. B) The price level will fall by a half. C) The price level will double. D)The price level will not change either. 2) During the financial crises and recession of 2007-09, the Fed lowered the federal funds rate target to 0-0.25%. However, long-term interest rates, like mortgage rates, were still fairly high. One thing the Fed did to lower long-term rates was that the Fed : A) bought long-term bonds B) lowered the long-term interest rates by lowering the reverse repo rate C) lowered the long-term interest rates by lowering the discount rate D) sold long-term bondsarrow_forwardFind the velocity of money when ?=$522M=$522, ?=105P=105, and ?R=$23YR=$23. M is the money supply, v is the velocity of money, P is the price level, and YR is the real gross domestic product (GDP). Round your answer to 2 decimal places.arrow_forwardWhich of the following statements about the income velocity of money (V) is NOT correct? a. It is an indicator of the demand for money as an asset (store of wealth). b. It is equal to the ratio of GDP to some measure of the stock of money such as M2. c. It is influenced by the public expectations regarding future rates of inflation. d. none of the above.arrow_forward
- Question 5. Consider an economy in which the money demand function takes the form: (M/P = L (i, Y) = Y/(Si) a. If output grows at rate g, at what rate will the demand for real balances grow (assuming constant nominal interest rates)? b. What is the velocity of money in this economy? c. If inflation and nominal interest rates are constant, at what rate, if any, will velocity grow? d. (How will a permanent (once-and-for-all) increase in the level of interest rates affect the level of velocity? How will it affect the subsequent growth rate of velocity?arrow_forwardE4 Assume the real money demand of an economy is:(Md/P) = 2×Yb(r + πe)-awhere 0 < b < 1 and 0 < a < 1.a) Use the real money demand above to determine the velocity of money.b) Does the quantity theory of money hold in this economy? Explain.c) Show with calculus how the velocity of money reacts to a change in output and a changein the nominal interest rate.d) Find the income and the nominal interest rate elasticities of money demand.arrow_forwarda-)The real interest rate is the opportunity cost of holding money." Is this statement is true or false? Comment on that. b-)If the government raises the income tax rate, we will see a negative effect on GDP and therefore the income velocity of money will increase." Comment on this statement. In your answer consider only the short-run effects of this policy changearrow_forward
- Some economics, notably Keynesians, believe that _______________.Group of answer choices A. since both V and Q are constants for an economy in short-run equilibrium, the equation of exchange becomes the quantity theory of money which explains prices B. even though velocity isnt constant, it is predictable C. If a change in M occurs, it may not only affect P, but also and at the same time affect Qarrow_forwardSuppose the real money demand function is given by () = 0.5Y - 50i, where i is the nominal interest rate in percent. The real interest rate r is fixed at 2%, the quantity of money M is 200, and output Y is 800. Assume that output and velocity are constant. If expected inflation is 1.5%, what are i and P?arrow_forwardAssume that the money demand function is (M / P)d = 2,200 – 200r, where r is the interest rate in percent. If the price level is fixed at P=2, and the Fed wants to fix the interest rate at 7 percent, it should set the money supply at: a. 2,000. b. 1,800. c. 1,600. d. 1,400.arrow_forward