Q1. Suppose that this year's money supply is $500 billion, nominal GDP is $10 trillion , and real GDP is $ 5 trillion.
a) What is the price level? What is the velocity of money?
b) Suppose that velocity is constant and the economy's output of goods and services rises by 5% each year. What will happen to nominal GDP and the price level next year if the Fed keeps the money supply constant?
c) What money supply should the Fed set next year if it wants to keep the price level stable?
d) What money supply should the Fed set next year if it wants an inflation of 10% ?
Q2. Let's consider the effects of inflation in an economy composed of only two people: Bob, a bean farmer, and Rita, a rice farmer. Bob and Rita both always consume equal amounts of rice and beans. In 2013, the price of beans was $1 and the price of rice was $3.
a) Suppose that in 2014 the price of beans was $2 and the price of rice was $6. What was inflation? Was Bob better off, worse off, or unaffected by the changes in prices? What about Rita?
b) Now suppose that in 2014 the price of beans was $2 and the price of rice was $4 . What was inflation? Was Bob better off, worse off, or unaffected by the changes in prices? What about Rita?
c) Finally, suppose that in 2014 the price of beans was $2 and the price of rice was $1.5 .What was inflation? Was Bob better off, worse off, or unaffected by the changes in prices? What about Rita?
d) What matters more to Bob and Rita-the overall inflation rate or the relative price of rice and beans?
Q3. If the tax rate is 40% , compute the before-tax real interest rate and the aftertax real interest rate in each of the following cases.
a) The nominal interest rate is 10%, and the inflation rate is 5%.
b) The nominal interest rate is 6%, and the inflation rate is 2%.
c) The nominal interest rate is 4% , and the inflation rate is 1%