Chapter 15
Inflation: A Monetary Phenomenon
True/False Questions
1. According to the text, inflation is a continuing increase in the price level.
ANSWER: T
2. The GDP deflator measures the prices of goods and services purchased by a typical urban
household.
ANSWER: F
3. If we were most interested in the impact of price changes on consumers, we would examine the
consumer price index (CPI).
ANSWER: T
4. The effects of inflation will be more pronounced if it is unanticipated.
ANSWER: T
5. Those depending on Social Security payments are adversely affected by inflation because Social
Security is not indexed for inflation.
ANSWER: F
6. Because government is a huge debtor, it benefits from inflation.
ANSWER: T
7. Inflation has been common throughout the history of the United States.
ANSWER: F
8. Money functions as a unit of account, a medium of exchange, and a store of value.
ANSWER: T
9. When money functions as a unit of account, it is used as payment for goods and services.
ANSWER: F
10. M1 includes currency, travelers' checks, demand deposits, other checkable deposits, and small
denomination time deposits.
ANSWER: F
11. Demand and other checkable deposits are the largest components of M1.
ANSWER: T
12. According to the equation of exchange, M x V = P x GDP.
ANSWER: T
13. According to the quantity theory of money, velocity varies with changes in real GDP.
ANSWER: F
14. According to the quantity theory of money, inflation results whenever the growth rate of the
money supply exceeds the growth rate of nominal GDP.
ANSWER: T
462
Test Bank  463
15. Inflation is a monetary phenomenon.
ANSWER: T
16. The rate of inflation will vary over the business cycle even if the growth rate of the money supply
is constant.
ANSWER: T
17. By increasing the growth rate of the money supply, the Federal Reserve can decrease the
inflation rate.
ANSWER: F
18. Most economists think that labor unions in the United States have contributed significantly to
inflation.
ANSWER: F
19. Fiscal policy cannot deal with inflation on a long-term basis.
ANSWER: T
20. Supply-side policies are a powerful anti-inflationary tool.
ANSWER: F
21. Wage and price controls are an example of an incomes policy.
ANSWER: T
22. If the economy suffers from inflation and unemployment as the result of a supply shock (such as
reduction in oil production), expansionary fiscal or monetary policy would reduce
unemployment but result in hyperinflation.
ANSWER: T
Multiple-Choice Questions
1. Inflation refers to:
a. an increase in prices.
b. a continuing increase in the general price level.
c. an increase in average prices.
d. all of the above.
ANSWER: b
2. Inflation can be measured by using:
a. the rate of change of the GDP deflator.
b. the average growth rate of output over the business cycle.
c. the inverse of the unemployment rate.
d. the average price index.
ANSWER: a
3. Deflation refers to:
a. a decrease in prices.
b. a continuing decrease in the general price level.
c. a decrease in average prices.
d. all of the above.
ANSWER: b
464  Chapter 15/Inflation: A Monetary Phenomenon
4. The GDP deflator is:
a. a weighted average of the prices of goods and services purchased by a typical urban
household.
b. a weighted average of the prices of goods and services purchased by a typical manufacturer.
c. a weighted average of the prices of all final goods and services produced in the economy.
d. a weighted average of the prices of all intermediate goods and services produced in the
economy.
ANSWER: c
5. The consumer price index (CPI) is:
a. a weighted average of the prices of goods and services purchased by a typical urban
household.
b. a weighted average of the prices of goods and services purchased by all consumers in the
economy.
c. a weighted average of the prices of all final goods and services produced in the economy.
d. a weighted average of the prices of all intermediate goods and services produced in the
economy.
ANSWER: a
6. The broadest price index is:
a. the CPI.
b. the producer price index for finished goods.
c. the GDP deflator.
d. the economy-wide deflator.
ANSWER: c
7. The consumer price index is not an accurate measure of the cost of living because:
a. it measures the goods and services bought by all urban households.
b. it is made up of a weighted average of prices.
c. it is made up of a variable basket of goods and services.
d. it does not fully account for changes in the quality of products.
ANSWER: d
8. Unanticipated inflation can result in:
a. a redistribution of income and wealth.
b. a increase in net exports.
c. an decrease in tax revenue.
d. a redistribution of income from debtors to creditors.
ANSWER: a
9. As a result of unanticipated inflation,
a. government will be made worse off due to increases in expenditures.
b. government will be made better off due to increases in revenues.
c. individuals living on fixed incomes will be made better off.
d. debtors will be made worse off due to increases in the interest rate.
ANSWER: b
Test Bank  465
10. A high and variable rate of inflation can:
a. cause resources to be concentrated on short-run projects.
b. increase economic uncertainty.
c. decrease the nation's productive capacity as people engage in speculation.
d. all of the above.
ANSWER: d
11. The U.S. government benefits from inflation because:
a. it is a debtor.
b. it is a creditor.
c. inflation causes its expenditures to increase.
d. revenues from personal taxes increase as inflation pushes people into higher income tax
brackets.
ANSWER: a
12. The rate of inflation increases. The government will benefit because:
a. it is a huge creditor.
b. tax revenues will increase.
c. the interest that must be paid on government bonds will decline.
d. productivity increases will cause economic growth to increase.
ANSWER: b
13. An increase in the inflation rate in the United States will:
a. cause an increase in net exports.
b. cause an increase in the relative price of imports.
c. cause a decrease in the relative price of exports.
d. cause a decrease in the relative price of imports.
ANSWER: d
14. Which of the following is not a function of money?
a. a standard of profitability.
b. a unit of account.
c. a medium of exchange.
d. a store of value.
ANSWER: a
15. The M1 money supply consists of:
a. currency, travelers' checks, demand deposits, and other checkable deposits.
b. currency, demand deposits, and small denomination savings accounts.
c. currency, demand deposits, other checkable deposits, and U.S. savings bonds.
d. currency and demand deposits.
ANSWER: a
16. The largest component of M1 is:
a. demand deposits.
b. other checkable deposits.
c. travelers' checks.
d. savings deposits.
ANSWER: a
466  Chapter 15/Inflation: A Monetary Phenomenon
17. Demand deposits are:
a. time deposits that banks must pay to depositors upon demand.
b. checking accounts at commercial banks, savings institutions, and credit unions.
c. checking accounts at commercial banks.
d. commercial bank deposits at one of the twelve Federal Reserve Banks.
ANSWER: c
18. A government established agency that controls the nation's money supply is a:
a. government bank.
b. Congressional established bank.
c. federal funds bank.
d. central bank.
ANSWER: d
19. When conducting monetary policy, the Federal Reserve focuses on:
a. changing government spending.
b. increasing taxes.
c. decreasing taxes.
d. changing the money supply.
ANSWER: d
20. In the United States, monetary policy is conducted by:
a. Congress.
b. the President.
c. a joint commission made up of the legislative and executive branches of the federal
government.
d. the Federal Reserve.
ANSWER: d
21. A theory emphasizing that the money supply is the principal determinant of nominal GDP is:
a. the income velocity theory of money.
b. the theory of money.
c. the volume theory of money.
d. the quantity theory of money.
ANSWER: d
22. According to the quantity theory of money, the main determinant of nominal GDP is:
a. the money supply.
b. the growth rate of the capital stock.
c. the interest rate.
d. the level of consumption.
ANSWER: a
Test Bank  467
23. Which of the following statements is correct?
a. The aggregate demand-aggregate supply model shows the relationship between the money
supply, the income velocity of money, the GDP deflator, and real GDP.
b. The equation of exchange shows the relationship between the money supply, the income
velocity of money, the GDP deflator, and real GDP.
c. The quantity theory of money shows the relationship between the money supply, the income
velocity of money, the GDP deflator, and real GDP.
d. Incomes policy shows the relationship between the money supply, the income velocity of
money, the GDP deflator, and real GDP.
ANSWER: b
24. According to the equation of exchange:
a. M x P = V x GDP.
b. V x P = M x GDP.
c. M x V = P x GDP.
d. M x V = GDP.
ANSWER: c
25. The number of times the money supply is used to purchase final goods and services during a year
refers to:
a. the income velocity of money.
b. the growth rate in velocity.
c. the income velocity of money times the money supply.
d. the growth rate in velocity times the money supply.
ANSWER: a
26. According to the quantity theory of money:
a. the growth rate in the money supply is constant.
b. velocity is constant.
c. the price level is constant.
d. the growth rate in nominal GDP is constant.
ANSWER: b
27. According to the quantity theory of money:
a. M/M = P/P + GDP/GDP.
b. M/M + P/P = GDP/GDP.
c. M/M + GDP/GDP = P/P
d. M/M = P/P - GDP/GDP
ANSWER: a
28. According to the quantity theory of money, an increase in the money supply will cause:
a. a proportional increase in the income velocity of money.
b. a proportional decrease in the income velocity of money.
c. a proportional increase in nominal GDP.
d. a proportional decrease in nominal GDP.
ANSWER: c
468  Chapter 15/Inflation: A Monetary Phenomenon
29. According to the quantity theory of money, the rate of inflation equals:
a. the rate of growth in the money supply.
b. the rate of growth in the money supply less the rate of growth in output.
c. the rate of growth in the money supply less the rate of growth in velocity.
d. the rate of growth in the money supply less the rate of growth in the price level.
ANSWER: b
30. The inflation rate may change even if the money supply grows at a constant rate because:
a. velocity is constant in the short run.
b. the growth rate of output is constant in the short run.
c. the growth rate of output may vary in the short run.
d. the growth rate of output is constant in the long run.
ANSWER: c
31. Many economists feel that union activity has little effect on inflation because:
a. unions attempt to prevent inflation by forcing management to include cost-of-living clauses
in contracts.
b. increased wages in union sectors may be lead to increased wages in non-union sectors.
c. labor unions lack significant bargaining power.
d. most union members are employed in small firms.
ANSWER: c
32. Economists argue that if an economy is highly monopolized:
a. it will have higher prices for its goods and services than a more competitive economy.
b. its average costs of production will be less than the average costs of production in a more
competitive economy.
c. it will have higher inflation rates than a more competitive economy.
d. it will have lower inflation rates than a more competitive economy.
ANSWER: a
33. The most appropriate policy to deal with inflation is:
a. contractionary fiscal policy.
b. contractionary monetary policy.
c. supply-side policy.
d. All of the above.
ANSWER: b
34. Fiscal policy cannot be used to deal with inflation on a long-term basis because:
a. government cannot lower the growth rate in the money supply indefinitely.
b. there is a limit as to how much government can cut taxes.
c. government may have difficulties on reaching a compromise as to the appropriate policy, a
change in taxes or a change in government spending.
d. there is a limit as to how much government can decrease spending.
ANSWER: d
35. Supply-side policies attempt to deal with inflation by:
a. increasing aggregate demand.
b. decreasing aggregate demand.
c. increasing aggregate supply.
d. decreasing aggregate supply.
ANSWER: c
Test Bank  469
36. Supply-side policies are an ineffective way to deal with inflation because:
a. it is difficult to increase the growth rate in aggregate supply.
b. supply-side policies can cause aggregate demand to decrease.
c. supply-side policies work so rapidly that they can cause a demand shock.
d. increases in aggregate supply are accompanied by decreases in employment.
ANSWER: a
37. Incomes policy attempts to control inflation by:
a. decreasing aggregate demand.
b. increasing aggregate supply.
c. controlling the rate of increase in prices, wages, and other forms of income.
d. Both a and b.
ANSWER: c
38. Economists feel that incomes policy, if successful in controlling inflation:
a. is the most desired policy because it allows government to decrease the rate of inflation
relatively quickly.
b. causes an underallocation of resources to the production of products for which there is high
demand.
c. causes an underallocation of resources to the production of products for which there is low
demand.
d. is very cost efficient.
ANSWER: b
39. Advocates of incomes policy believe inflation is caused by:
a. an excessive growth in the money supply.
b. an excessive growth in aggregate demand.
c. ineffective unions.
d. excessive monopoly power.
ANSWER: d
40. Suppose the economy is currently suffering from inflation. In order to decrease the price level:
a. the growth rate in the money supply could be decreased.
b. government spending could be increased.
c. aggregate supply could be decreased.
d. taxes could be decreased.
ANSWER: a
41. Decreasing the money supply will cause:
a. an increase in both aggregate demand and the price level.
b. a decrease in both aggregate demand and the price level.
c. an increase in aggregate demand and a decrease in the price level.
d. an decrease in aggregate demand and an increase in the price level.
ANSWER: b
470  Chapter 15/Inflation: A Monetary Phenomenon
Critical Thinking Multiple-Choice Questions
42. If you wish to measure price changes of the goods and services bought by households, you
should use:
a. the consumer price index.
b. the GDP deflator.
c. the producer price index for finished goods.
d. the producer price index for crude materials.
ANSWER: a
43. If you wish to measure price changes of final goods and services produced in the economy, you
should use:
a. the consumer price index.
b. the GDP deflator.
c. the producer price index for intermediate goods.
d. the producer price index for crude materials.
ANSWER: b
44. Suppose the CPI was 132.00 in 1997 and is 135.30 in 1998. What is the rate of inflation over the
period?
a. 2.43 percent.
b. 2.5 percent.
c. 3.3 percent.
d. 9.77 percent.
ANSWER: b
45. Who is likely to lose the least from an unanticipated inflation?
a. Chris, who borrowed $5,000 from Todd at a fixed rate of interest.
b. Janice, whose wage is determined by a five year contract that does not include a cost of
living adjustment.
c. Beth, who works for a firm that gives its employees an annual cost of living adjustment.
d. Steve, who has put his financial assets into a savings account paying a fixed rate of interest.
ANSWER: c
46. Who is most likely to gain as a result of unanticipated inflation?
a. Roberta who invested $5,000 in real estate before the inflation began.
b. Hector who invested $10,000 in government bonds that pay a fixed rate of interest of 5.3
percent.
c. James who just signed a two-year consulting contract that does not include a cost of living
adjustment.
d. Rebecca who put $2,000 in her savings account.
ANSWER: a
47. Who is most likely to lose as a result of unanticipated inflation?
a. Jerry, who has borrowed $500 from Scott.
b. Sandy, who lives on a monthly pension.
c. Mary, who has invested her financial resources in gold.
d. Joan, whose wages are determined by a five year contract which includes a cost of living
adjustment clause.
ANSWER: b
Test Bank  471
48. Who is most likely to lose as a result on unanticipated inflation?
a. Margaret who receives Social Security.
b. James, who borrowed $2,000 from Jack.
c. Jack who loaned James $2,000.
d. Jennifer who has signed a contract with her employer that includes a cost of living
adjustment clause.
ANSWER: c
49. Suppose borrowers and lenders underestimate the rate of inflation. In this case:
a. borrowers gain at the expense of lenders.
b. lenders gain at the expense of borrowers.
c. neither borrowers or lenders gain.
d. both borrowers and lenders gain.
ANSWER: a
50. Suppose that economic actors correctly anticipate the rate of inflation. In this case:
a. debtors will gain at the expense of creditors.
b. creditors will gain at the expense of debtors.
c. persons on fixed incomes will not be affected by inflation.
d. persons on fixed incomes will still lose as a result of inflation.
ANSWER: d
51. Tei compares the price of a Toyota Celica with the price of a Nissan Stanza. In this example
money is functioning as:
a. a medium of exchange.
b. a store of value.
c. a unit of account.
d. a standard of deferred payment.
ANSWER: c
52. Maria saves $300 each month in order to buy a house. In this example money is functioning as a:
a. medium of exchange.
b. store of value.
c. unit of account.
d. standard of deferred payment.
ANSWER: b
53. Abraham buys lunch at work everyday. In this example money is functioning as a:
a. medium of exchange.
b. store of value.
c. unit of account.
d. standard of deferred payment.
ANSWER: a
54. In which of the following examples is money functioning as a medium of exchange?
a. Robin compares the price of apples and oranges.
b. Kathy saves her money to purchase a personal computer.
c. Scott puts money into a personal retirement account.
d. Bill purchases a new pair of Nike shoes.
ANSWER: d
472  Chapter 15/Inflation: A Monetary Phenomenon
55. Suppose the money supply is $1,500 billion, the price level is 2.50, and real GDP is $3,000
billion. The income velocity of money is:
a. 3.
b. 4.
c. 5.
d. 6.
ANSWER: c
56. Suppose the rate of growth in output is 3.5 percent. The rate of growth in the money supply is 6.0
percent. The rate of growth in velocity is 0 percent. What is the inflation rate?
a. 9.5 percent.
b. 6.0 percent.
c. 3.5 percent.
d. 2.5 percent.
ANSWER: d
57. Suppose the growth rate in the money supply is 8 percent. If the growth rate in real GDP is 3
percent, the quantity theory of money would predict:
a. an inflation rate of 8 percent.
b. an inflation rate of 5 percent.
c. an inflation rate of 3 percent.
d. an inflation rate of 2 percent.
ANSWER: b
58. Suppose the long-run annual growth rate in real GDP is 4 percent. If monetary authorities want
stable prices over the long-run, they should allow the money supply to:
a. increase at 4 percent annually.
b. increase between 1 percent and 4 percent annually.
c. decrease at 4 percent annually.
d. This cannot be determined from the information given.
ANSWER: a
59. Suppose the annual growth rate in real GDP is 3.5 percent. If the money supply grows at an
annual rate of 4 percent we would expect:
a. inflation.
b. deflation.
c. hyperinflation.
d. under-inflation.
ANSWER: a
60. Suppose real GDP grows by 4 percent over the 1997 - 1998 time period. Over this same period,
the money supply grows at a rate of 3.5 percent. We would expect:
a. inflation.
b. deflation.
c. hyperinflation.
d. under-inflation.
ANSWER: b
Test Bank  473
Use the following diagram to answer questions 61 – 62.
GDP Deflator
AS 1
AS 3
AS 2
.C
P2
P1
.A
.B
AD
AD
AD
1
0
Q1
Q2
Q3
3
2
Real GDP
61. Suppose the economy moves from equilibrium at point A to equilibrium at point B. In this
instance, the monetary authorities are most likely:
a. allowing the money supply to grow at a faster rate than real GDP.
b. allowing the money supply to grow at a slower rate than real GDP.
c. allowing the money supply to grow at a rate equal to real GDP.
d. pursuing restrictive monetary policy.
ANSWER: c
62. Suppose the economy moves from equilibrium at point B to equilibrium at point C. In this
instance, the monetary authorities are most likely:
a. allowing the money supply to grow at a faster rate than real GDP.
b. allowing the money supply to grow at a slower rate than real GDP.
c. allowing the money supply to grow at a rate equal to real GDP.
d. pursuing restrictive fiscal policy.
ANSWER: a
63. Suppose monetary authorities allow the money supply to grow at a constant rate of 3 percent.
During this same period, the economy experiences inflation. What is the most likely explanation
for this phenomenon?
a. A decrease in the income velocity of money.
b. An increase in the income velocity of money.
c. A decrease in investment.
d. An increase in the growth rate of GDP.
ANSWER: b
474  Chapter 15/Inflation: A Monetary Phenomenon
Use the following diagram to answer questions 64 – 66.
GDP Deflator
AS 2
AS 1
AD
2
AD
1
0
Real GDP
64. In the above diagram, which of the following illustrates inflation caused by the activity of labor
unions?
a. an shift in aggregate demand from AD1 to AD2 due to the increased purchasing power of
union members.
b. a shift in aggregate demand from AD1 to AD2 due to the increased quality of union products.
c. a shift in aggregate supply from AS2 to AS1 due to the restriction of employment
opportunities by unions.
d. a shift in aggregate supply from AS1 to AS2 due to union activity which forces wages up.
ANSWER: d
65. In the above diagram, which of the following illustrates inflation caused by reduction in
production of oil?
a. a shift in aggregate demand from AD1 to AD2.
b. a shift in aggregate demand from AD2 to AD1.
c. a shift in aggregate supply from AS2 to AS1.
d. a shift in aggregate supply from AS1 to AS2.
ANSWER: d
66. In the above diagram, if the economy experiences inflation and unemployment caused by
reduction in production of oil, the best policy to deal with both of these problems should target
to:
a. shift aggregate demand from AD1 to AD2.
b. shift aggregate demand from AD2 to AD1.
c. shift aggregate supply from AS2 to AS1.
d. shift aggregate supply from AS1 to AS2.
ANSWER: c
Test Bank  475
67. Suppose all industries in the Centralized States are monopolized. It is likely that:
a. this country will experience higher rates of inflation than a country whose industries are
competitive.
b. this country will experience lower rates of inflation than a country whose industries are
competitive.
c. this country will have higher prices for its goods and services than a country whose
industries are competitive.
d. this country will have lower prices for its goods and services than a country whose industries
are competitive.
ANSWER: c
68. Suppose politicians attempt to lower inflation by increasing worker productivity. In this case,
politicians are using:
a. contractionary fiscal policy.
b. contractionary monetary policy.
c. supply-side policy.
d. expansionary growth policy.
ANSWER: c
Essay and Discussion Questions
1. Evaluate the following statement. "During the past year the CPI increased by 12 percent.
This means that the cost of living went up by 12 percent."
The student should note that there are several shortcomings associated with using the CPI as a
measure of the cost of living. For example, the CPI measures the price change of a market basket
of goods and services purchased by a typical urban household. To the extent that an individual's
consumption patterns differ from the "typical" household's, the CPI will not be an accurate
measure of the cost of living. The CPI can overstate the cost of living because it is based on a
fixed basket of goods and services. Consumers generally alter consumption as prices change.
The CPI can also overstate the cost of living because it makes no adjustment for quality changes
in products.
2. Evaluate the following statement. "Like other economic actors, government is typically
harmed by inflation."
Government is made better off during inflationary periods for two reasons. One, government is a
huge debtor. The student should recall that periods of inflation are beneficial to debtors because
these debtors repay loans with dollars that are worth less in terms of purchasing power.
Government also benefits because nominal income tends to increase during times of inflation.
This tends to push corporations into higher tax brackets, thereby increasing governmental tax
revenues. Because of these benefits, it may be true that government's incentive to pursue strict
anti-inflationary policies is lessened.
3. Evaluate the following statement. "Labor unions are detrimental to the economy.
Through the process of collective bargaining, they force wages up. Firms respond by
passing this increased cost on to consumers in the form of higher prices resulting in
inflation."
It is unlikely that unions are a source of inflation. Many unions lack the bargaining power
necessary to force their members' wages up more rapidly than they would otherwise increase.
Even if unions could force wages up, its unlikely that wages in general would be affected. The
majority of workers are not covered by union contracts. Further, to the extent that unions can
476  Chapter 15/Inflation: A Monetary Phenomenon
increase members' wages, wages in non-union sectors are depressed. As a result, unions are an
unlikely source of inflation.
4. "Inflationary policies followed by the government helped to increase the trade deficit." Is
this statement true or false? Defend your answer.
It is true that inflation will increase the trade deficit. If the rate of inflation in the United States is
greater than that experienced by the rest of the world, the relative price of exports will increase
and they will become less competitive. At the same time, because the relative price of imports
has decreased, they become more attractive to domestic buyers. The decrease in exports and the
increase in imports will work to increase the trade deficit. Inflation will also cause the dollar to
depreciate in terms of foreign currencies. However, it will take a number of years for this
depreciation to compensate for the effects of higher inflation rates. Thus, to the extent that
government pursues inflationary policies, the trade deficit will tend to increase.
5. Evaluate the following statement. "If incomes policies are successful, they will likely result
in a misallocation of resources."
This statement is correct. Suppose there is an increase in demand for a specific product. In the
absence of an incomes policy, the increase in demand would be accompanied by an increase in
price. This increase in price would signal firms to increase production. If the incomes policy is
successful, price will not increase, and there will be no change in production. Thus, too few
resources will be devoted to production of the good whose demand has increased, and too many
resources will be devoted to the production of other goods and services.
Problems
1. Suppose the CPI is currently 147. If the CPI last year was 140, what was the rate of
inflation over the period.
The rate of inflation is calculated as:
Inflation = CPI1 - CPI0 x 100
CPI0
CPI1 is this period's price level and CPI0 is the previous period's price level. Using this equation,
we find the rate of inflation to be:
Inflation = 147 - 140 x 100
140
Inflation = 5 percent.
2. Suppose the GDP deflator was 120 in 1997 and 123.6 in 1998. What was the rate of
inflation over the period?
Inflation = 123.6 - 120 x 100
120
Inflation = 3 percent.
3. Suppose the GDP deflator in 1997 was 140.0 and the GDP deflator in 1998 was 146.72
What was the rate of change in the GDP deflator?
Rate of Change = 146.72 - 140.0 x 100
140.0
Rate of Change = 4.8 percent.
Test Bank  477
4. Given the information in the following table, find M1.
Currency
Travelers' checks
Demand deposits
Other checkable deposits
Small denomination time deposits
Repurchase agreements
Eurodollars
$395
5
950
900
372
91
235
M1 is defined as currency, travelers' checks, demand deposits, and other checkable deposits.
According to this definition, M1 is $2,250 (395 + 5 + 950 + 900).
5. Suppose the money supply is $450 billion and velocity is 3. What is nominal GDP?
Money supply times velocity is equal to nominal GDP, therefore nominal GDP is $1,350 billion
($450 x 3).
6. Suppose the money supply is $500 billion and nominal GDP is $3,500 billion. What is
velocity?
Velocity is equal to nominal GDP divided by the money supply; therefore, velocity is 7
(3,500/500).
7. Suppose the rate of growth in the money supply is 4.7 percent. What is the growth rate in
nominal GDP?
The growth rate in nominal GDP is equal to the growth rate in the money supply, or 4.7 percent.
8. Suppose the growth rate in real GDP is 4 percent and the growth rate in the money supply
is 7.3 percent. What is the rate of inflation?
The rate of inflation is equal to the difference between the growth rate in the money supply and
the growth rate in real GDP, or 3.3 percent.