Answer to Question #278040 in Macroeconomics for kika

Question

7. Suppose the velocity of money is constant and potential output grows by 5% per year. For each of the following money supply growth rates, what will the inflation rate be? a. 4% b. 5% c. 6%

Answer 1

Money supply × velocity of money = price level × real GDP.

The left side of this equation is the product of two variables, the money supply and the velocity of money. The right side is likewise the product of two variables.

Growth rate of the money supply + growth rate of the velocity of money

= inflation rate + growth rate of output.

By assuming that the velocity of money is a constant, is the same as saying that its growth rate is zero. Rearranging the equation, we discover that the long-run inflation rate depends on the difference between how rapidly the money supply grows and how rapidly output grows:

Inflation rate = growth rate of money supply − growth rate of output.

a) Inflation rate= 4%-5%=-1%

b) Inflation Rate=5%-5%=0%

c) Inflation Rate= 6%-5%= 1%