Macro Econ Homework free essay sample

Other things remaining unchanged, as the quantity of money in circulation increases, the price level also increases in direct proportion and value of money decreases. What does the assumption of constant velocity imply? When we make the assumption that the velocity of money is constant, then the equation becomes the quantity theory of money. The quantity equation can be seen as a theory of what determines nominal GDP (the level of prices). With MV = PY (where velocity is constant), then a change in the quantity of money M must cause a proportionate change in nominal income PY. That is, if velocity is fixed, then the quantity of money determines the nominal value of the economy’s output/GDP. Suppose a country has a money demand function (M/P)^d = kY, where k is a constant parameter. The money supply grows by 12 percent per year, and real income grows by 4percent per year. We will write a custom essay sample on Macro Econ Homework or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page a. To ? nd the average in? ation rate the money demand function is %growth Md ? %growth P = %growth Y 12% 4% = 8% b. Increase in real income growth will result in a lower average inflation rate. For example, if real income grows at 6% and money supply growth remains at 12%, then inflation falls to 6%. Here a larger money supply is required to support a higher level of GDP, which results in lower inflation. c. 1/k = V When people hold a larger percent of their income (large k), money changes hands infrequently, or V is small. When people hold smaller percent of their income (k is small), money changes hands frequently because V is large. The money demand parameter k and the velocity of money V are opposite sides of the same coin. . If velocity growth is positive, then all else the same in? ation will increase. For example, let’s say that the money supply grows by 12% and real income grows by 4 percent. When velocity growth is zero, in? ation is 8%. Suppose now that velocity grows 2%: this will cause prices to grow by 10%. In? ation increases because the same quantity of money is being used more often to purchase the same amount of goods. Here the money supply should gr ow more slowly to compensate for the positive growth in velocity.