Ch. 20 -Practice 1. If M = the money supply; Y = real output, P = the price level, and V = velocity, which of the following equals the velocity of money? A. (Y x M)/P B. (P x M)/Y C. (P x Y)/M D. (P x Y) +M 2. If the equation of exchange is MV = PY the Y represents: A. Nominal GDP B. Real GDP C. Potential output D. Economic growth 3. According to the equation of exchange, if real output and the money supply stay the same and the price level increases: A. The velocity of money has to increase B. The velocity of money has to decrease C. The real GDP had to rise D.

Nominal GDP remains constant 4. Which of the following expresses the equation of exchange? A. MY = PV B. MV = Y C. MV = PY D. MP = VY 5. Using the equation of exchange, if inflation is 1. 5%, real output grows by 3. 0%, and the growth rate of money is 5. 0%, the change in the velocity of money is: A. Zero; velocity is constant B. -0. 5% C. +4. 5% D. +0. 5% 6. Using the equation of exchange, if real GDP increases by 3. 0%, the velocity of money grows by 1. 0% and the growth rate of money is 3. 0%; what is the rate of inflation? A. +1. 0% B. It is constant or a 0% change C.

It is the same as the growth rate of money, or 3. 0% D. -1. 0% 7. Using the equation of exchange, if inflation is 1%, the velocity of money grows by 1. 0% and the growth rate of money is 3. 0%; what is real growth? A. +3. 0% B. 1% C. 4. 0% D. -1. 0% 8. If velocity of money is constant; real growth in the output of the economy is +2. 5%; and inflation is 2. 0%; what is the growth rate of money? Here we can employ the percentage change form of the equation of exchange where: %M + %V = %P + %Y. Inserting the known values and solving for the %M we obtain: %M + 0 = 2. 0 + 2. or %M = 4. 5. 9. The CPI is a commonly used and closely watched measure of inflation. However, it has limitations. What are they? Economists maintain that the CPI, which is a common measure of inflation, overstates the true rate of inflation by about one percentage point per year. This is primarily due to the fact that the CPI is measured using a fixed basket of goods. The bias in the CPI arises from several sources. First, consumers’ buying patterns change, and in particular, consumers can substitute away from higher priced goods towards less expensive substitutes.

A second source of bias arises from the fact that quality improvements are not always adjusted for, so what looks like a higher price may simply be an improvement in quality. 10. Assuming a constant nominal GDP, would the velocity of M1 equal the velocity of M2? Explain. No, the velocity of M1 would be greater than the velocity of M2. The formula for velocity is nominal GDP/M. Given a constant numerator and the fact that M2 ; M1 the velocity of M1 has to exceed the velocity of M2.