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Chapter 20: Q 24. (page 548)

If velocity and aggregate output remain constant at 5and \(1,000billion, respectively, what happens to the price level if the money supply declines from \)400 billion to$300 billion?

Short Answer

Expert verified

Price level falls from$2to$1.63.

Step by step solution

01

Step 1. Define velocity.

A velocity of an item is a function of frequency and is defined as the rate of growth of its location with respect to the criteria of reference.

02

Step 2. What happens to the price level?

M×V=P×Y

At the initial stage:

V=5Y=1,000M=400

So,

400×5=P×1000P=20001000=2

V=5Y=1,000M=325

325×5=P×1000P=16251000=1.625

So, price level falls from 2to1.63.

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Most popular questions from this chapter

Why is Keynes’s analysis of the speculative demand for money important to his view that velocity will undergo substantial fluctuations and thus cannot be treated as constant?

Both the portfolio choice and Keynes’s theories of the demand for money suggest that as the relative expected return on money falls, demand for it will fall. Why does the portfolio choice approach predict that money demand is affected by changes in interest rates? Why did Keynes think that money demand is affected by changes in interest rates?

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