For a country A, the real GDP growth rate is 8% and inflation is 4%. If the velocity of money remains constant, what is the required change in real money balances to keep inflation constant?

Question

For a country A, the real GDP growth rate is 8% and inflation is 4%. If the velocity of money remains constant, what is the required change in real money balances to keep inflation constant?

BlackTom AI · Accepted Answer

We start by restating the problem to anchor the analysis: With real GDP growth of 8% and inflation at 4%, and with velocity of money constant, what change in real money balances is needed to keep inflation unchanged?

Option a: 12%
- If we use the quantity equation in growth form: ΔM/M + ΔV/V = ΔP/P + ΔY/Y. With ΔV/V = 0 (velocity constant), this gives ΔM/M = ΔP/P + ΔY/Y = 4% + 8% = 12%. This calculates the growth rate of the money supply needed to keep inflation at 4% given real GDP growth. However, the question asks for the change in real money balances (M/P), not the nominal money stock M. So while 12% is the required growth rate of M, it does not directly represent the change in real money balances, which are M/P. Therefore, this option describes the nominal money growth, not the real money balances, making it incorrect as the requested measure.

Option b: 8%
- To get the change in real money balances, we look at the growth rate of M/P, which is (ΔM/M) − (ΔP/P). From above, ΔM/M = 12% and ΔP/P = 4%, so Δ(M/P)/(M/P) = 12% − 4% = 8%. This exactly matches the asked quantity—the required change in real money balances to keep inflation constant when velocity is fixed and output grows.

Option c: 4%
- This would imply that the real money balances grow at the same rate as inflation alone, ignoring the 8% real GDP growth. Since real GDP growth adds to the money balance needs to support higher real activity, allocating only 4% to real money balances would leave insufficient money to finance the higher output growth, leading to a mismatch and likely higher inflation, given the constant velocity assumption. Hence, 4% is too small and incorrect for the stated condition.

In summary, the key relationships are the quantity equation in growth form with velocity fixed, and the realization that real money balances grow at the difference between the nominal money growth and inflation. This yields 8% for the change in real money balances, not 12% or 4%.

BU.220.610.51.FA25 M4 Practice Quiz

For a country A, the real GDP growth rate is 8% and inflation is 4%. If the velocity of money remains constant, what is the required change in real money balances to keep inflation constant?

View Explanation

Log in for full answers

Similar Questions

If the real GDP per capita growth is 2.1 percent per year, the population growth rate is 3.2 percent per year, the money growth rate is 4.7 percent per year, and velocity is constant then, according to the quantity theory of money, the inflation rate is ________ percent in the long run.

According to the assumptions of the quantity theory of money, if the money supply increases by 5 percent, then[Fill in the blank]

If the growth rate of real GDP is 3.5 percent per year, the money supply grows at a rate of 7 percent, and the velocity is constant, using the quantity theory, the inflation rate is ______ percent. Round your answer to the nearest hundredth of a percent.

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler