11S_Quiz1_Sol - Econ 204 Instructor J Li QUIZ 1 ANSWERS...

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Econ 204 Instructor: J. Li 1 QUIZ 1 ANSWERS, SPRING 2011 Given: %∆ V = 0, %∆ M =4%, %∆ Y =2%, r = 2%. (a) Describe the Quantity Theory of money. Find: i . (i) Quantity Theory of money The Quantity Theory of Money assumes velocity is stable/constant. +0.25 It concludes that the money growth rate determines the inflation rate. (It predicts “one-for-one” relation between changes in the money growth rate and changes in the inflation rate. Either version of the above is OK.) +0.25 (ii) %∆ M + %∆ V = %∆ P + %∆ Y %∆ P = π = 4 − 2 = 2% +0.25 So i = r + = 2 + 2 = 4% +0.25 Given: %∆ Y falls to 1%. (b) Find: M . %∆ M + %∆ V = %∆ P + %∆ Y %∆ P = π = 4 − 1 = 3% +0.25 So ∆ = 3 – 2 = 1% +0.25 To maintain 2% inflation with constant velocity, the BoC should reduce money supply by 1%; that is, M =3% +0.5 Given: ( M / P ) d = Y / i 0.1 ; initially, Y = 100, i = 4%, E = 0 and P = 1. (c)
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