10. Using money creation to pay for government spending

Consider Tralfamadore, a hypothetical country that produces only cakes. In 2017, a cake is priced at $2.00.

Complete the first row of the table with the quantity of cakes that can be bought with $700.

Hint: In this problem, assume it is not possible to buy a fraction of a cake, and alwaysround downto the nearest whole cake. For example, if your calculations result in 1.5 cakes, the answer should be 1 cake.

Price of a Cake Cakes Bought with $700

Year (Dollars) (Quantity)

2017 2.00 _____

2018 ______ _______

Suppose the government of Tralfamadore cannot raise sufficient tax revenue to pay its debts. In order to meet its debt obligations, the government prints money. As a result, the money supply rises by 40% by 2018.

Assuming monetary neutrality holds, complete the second row of the table with the new price of a cake and the new quantity of cakes that can be bought with $700 in 2018.

The impact of the government's decision to raise revenue by printing money on the value of money is known as the___(inflation tax, velocity of money, classical dichotomy, Fisher effect).