We have the following information about an economy. Answer the following questions. Show
your work.
Money supply = $ 22 million
Nominal GDP = $99 million
Real GDP = $90 million

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a) Calculate the price level and the velocity of money in this economy.

b) Suppose that the velocity stays constant year to year. The output of goods and services
rises by 3% each year. The central bank is increasing the money supply by 7% each year.
How much will the nominal GDP and the price level increase annually as a result?

c) Calculate the new level of nominal GDP and the price level after one year.

d) Assume the same growth rate in output as above. Instead of simply growing the money
supply by 7% annually, the central bank’s objective is now to keep the price level constant
from year to year. How much should they increase the money supply annually (in
percentage terms) to maintain the price level constant?

e) What is the new level of the money supply after one year is the central bank follows the
growth rate you found in part (d)?

f) Suppose again, like in part (b), that the output increases by 3% and the money supply
increases by 7% for a number of years. Then one year, for some unknown reason, the
growth rate of output drops to only 1% If the central bank keeps growing the money
supply by 7%, what will be the new inflation rate in this economy?

g) Who benefits and who loses from this unexpected change in inflation rate - borrowers or
lenders? Explain.