Author Question: Fisheria is a country in which the quantity theory of money operates. The country has a constant ... (Read 115 times)

torybrooks · **on:** Jun 29, 2018

Fisheria is a country in which the quantity theory of money operates. The country has a constant population, capital stock, and technology.

In 2010, real GDP was 300 million, the quantity of money was 60, and the velocity of circulation of money was 10. In 2015, the price level rose by 20 percent. a) What was the price level in 2014? (The price level is measured by the GDP deflator, which is 100 in the base year. So the price level from the equation of exchange needs to be multiplied by 100 to convert it to the GDP deflator.) b) What was real GDP in 2015? c) What was the velocity of circulation in 2015? d) What was the quantity of money in 2015?

Question 2

The figure above shows the market for transportation services, which produces an external cost due to the air pollution that is created. Suppose that the government decides to introduce a pollution tax.

What is the tax per vehicle mile that will achieve the efficient outcome? A) 2
B) 4
C) 6
D) 8

Dunkey · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

a) The equation of exchange states that the quantity of money, M, multiplied by the velocity of circulation, V, equals real GDP, Y, multiplied by the price level, P. In terms of a formula, the equation of exchange is that M V = P Y. This formula shows that P = MV/Y. Using this result, the price level is (60 10 )/300 = 2.0, which must be multiplied by 100 so that the price level is 200.
b) Real GDP does not change because the country has a constant population, capital stock, and technology, and, according to the quantity theory of money, real GDP is not influenced by changes in the quantity of money. So real GDP in 2015 is 300 million.
c) The quantity theory of money asserts that the velocity of circulation is not influenced by the quantity of money. So the velocity of circulation remains constant at 10.
d) From the equation of exchange, the quantity of money is M = PY/V. Because the price level in 2015 increased by 20 percent, the price level in 2015 is 200 1.2 = 240. So using the equation of exchange formula, M = (240/100 ) 300/10 = 72 billion. Another way to calculate the quantity of money in 2015 is to notice that according to the quantity theory, a change in the quantity of money has no effect on velocity and real GDP. So if the price level rises by 20 percent, to balance the equation of exchange, the quantity of money must also increase by 20 percent. So from this approach, in 2015 the quantity of money in Fisheria is 60 billion 1.2 = 72 billion.

Answer to Question 2

C