Chapter 7, Problem 6NP

a)

To determine

To describe: The values of real money supply and current price level are to be determined when the money supply is growing at rate 10%.

Answer to Problem 6NP

The real money supply = 10

The current price level = 30

Explanation of Solution

The equation to calculate the real money demand function −$L(Y,r+{\pi }^e)=\frac{0.01Y}{r+{\pi }^e}$ ………………Equ (1)

Where, $r$ = real interest rate ${\pi }^e$ = expected inflation

Now, the following equation to calculate the growth of money supply −${\pi }^e=\frac{\Delta M}{M}$

  ${\pi }^e=0.1or10\%$

Now, put the given values in Equ (1) −$L(Y,r+{\pi }^e)=\frac{0.01Y}{r+{\pi }^e}$

  $L(Y,r+{\pi }^e)=\frac{0.01\times 150}{0.05+0.10}$

  $L(Y,r+{\pi }^e)=\frac{1.5}{0.15}=10$

At the condition of equilibrium, the real money demand is equal to the real money supply.

Given that,

M = 300

Now, the equation can be represented as −$L(Y,r+{\pi }^e)=\frac{M}{P}$

Or, $P=\frac{M}{L(Y,r+{\pi }^e)}$ ………………………….Equ (2)

Now, put the given values in Equ (2) −$P=\frac{300}{10}=30$

The price level in the economy = 30

The equation to calculate the real money supply −$real{M}^s=\frac{Nominal{M}^s}{Pricelevel}$ ……………….Equ (3)

Now, put the calculated values in Equ (3) −$real{M}^s=\frac{300}{30}=10$

Economics Concept Introduction

Introduction:

The real money supply can be defined as the nominal money supply which is adjusted for the effect of inflation.

b)

To determine

To describe: The values of real money supply and current price level are to be determined when the money supply is growing at rate 5%.

Answer to Problem 6NP

The real money supply = 15

The current price level = 20

Explanation of Solution

Given that −

The money supply is growing at rate 5%.

The equation to calculate the growth of nominal supply −${\pi }^e=\frac{\Delta M}{M}=0.05or5\%$

The equation of the demand function is represented as −$L(Y,r+{\pi }^e)=\frac{0.01Y}{r+{\pi }^e}$

Put the given or calculated values in the above equation −$L(Y,r+{\pi }^e)=\frac{0.01\times 150}{0.05+0.05}=\frac{1.5}{0.10}$

  $L(Y,r+{\pi }^e)=15$

At the condition of equilibrium, the real money demand is equal to the real money supply.

Given that −

M =300

Now, the equation can be represented as −$L(Y,r+{\pi }^e)=\frac{M}{P}$

Or, $P=\frac{M}{L(Y,r+{\pi }^e)}$ ………………………….Equ (2)

Now, put the values in above Equ −$P=\frac{300}{15}=20$

The new price level in the economy = 20

The equation to calculate the real money supply −$real{M}^s=\frac{Nominal{M}^s}{Pricelevel}$ ……………….Equ (3)

Now, put the calculated values in Equ (3) −$real{M}^s=\frac{300}{20}=15$

The real money supply is 15.

Economics Concept Introduction

Introduction:

The real money supply can be defined as the nominal money supply which is adjusted for the effect of inflation.