Hwk9_sol - Economics 345 Prof. Irina Telyukova Fall 2008...

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Economics 345 Prof. Irina Telyukova Fall 2008 Homework Assignment 9 SOLUTIONS 1. Mishkin and Serletis, p. 545 (ch 21) (1) Velocity is defined as V=PY/M. Thus, in each year you compute velocity as follows: 2004: V=1000/100=10 2005: V=1200/110=10.9 2006: V=1440/121= 11.9 Velocity is growing at about 9% per year. (2) Since velocity is given as V=PY/M, we can use this to compute nominal GDP as PY=V*M. Thus, in the first instance, we have PY=5*$200b=$1000b or $1 trln. In the second instance, PY=5*$300b=$1500b or $1.5 trln. So nominal output increases by $500 billion dollars. (3) Mathematically, the quickest way to see this is the following formula: % 10 % 20 % 30 ) ( ) ( ) ( = + = Δ Δ + Δ = Δ = Δ = PY V M MV PY MV PY So nominal GDP will decline by 10%. (4) If credit cards were made illegal, money (currency) would once again become the dominant way of conducting purchases (along with cheques, which are included in most monetary aggregates). Thus, velocity would fall because a greater quantity of the money supply (M) would be needed to carry out the same level of transactions (PY). That is, increased M and fixed PY means that V=PY/M would then fall. (6) Again, we use the velocity definition. V=PY/M Æ P=MV/Y. Thus, in the first instance, we have P=(5*$400b)/1000=2000/1000=2. In the second instance, we have P=(5*$300b)/1000=1500/1000=1.5. Thus, the price level declines from 2 to 1.5. (10) Because this view indicates that money demand and hence velocity is affected by interest rates, and since interest rates fluctuate a lot, velocity will as well. Furthermore, changes in people’s expectations about what the normal level of interest rates are will cause money demand and hence velocity to fluctuate as well. Keynes’s analysis of the speculative demand for money thus suggests that velocity will be far from constant; rather, it will undergo substantial fluctuations.
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(13) Answer in the book. (14) Both Keynes and Friedman believed that expected returns on money would affect money demand. In Keynes’s view, a rise in interest rates would lead to a lower relative expected return on money and hence a lower demand for money. In Friedman’s view, on the other hand, relative returns on money would respond to the overall increase in the interest rates as well: a rise in interest rates leads not only to a rise in opportunity cost of holding money, but also to an increase in implicit returns on chequable deposits, so the relative expected return of money only falls by a small amount. Hence, in Friedman’s view, the demand for money changes little when interest rates rise. (15)
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This note was uploaded on 06/21/2011 for the course ECON 345 taught by Professor Sumaila during the Spring '09 term at The University of British Columbia.

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Hwk9_sol - Economics 345 Prof. Irina Telyukova Fall 2008...

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