Assuming a long-run relationship, if nominal money supply grows at a rate of 6.5%, real output growth is 3.2%, and the inflation rate is 2.8%, what is the percentage change in velocity?
A)6)1%
B)0)5%
C)0%
D)-0.1%
E)-0.5%

Question

Quizplus · Accepted Answer

Using the equation of exchange, we can solve for velocity:
M x V = P x Y
Velocity (V) = (P x Y) / M

In this case, nominal money supply (M) is growing by 6.5%, so we can assume that velocity will decrease in order to keep P x Y at a constant level. Therefore, we need to solve for the percentage change in velocity:

Percentage change in velocity = ((new velocity - old velocity) / old velocity) x 100%

Plugging in the given values:
Old velocity = (2.8% + 1) / (3.2% + 1) = 0.99215
New velocity = (2.8% + 1) / (3.2% + 1.065) = 0.98627

Percentage change in velocity = ((0.98627 - 0.99215) / 0.99215) x 100% = -0.592%, which is closest to answer choice E (-0.5%).

Assuming a Long-Run Relationship, If Nominal Money Supply Grows at a Rate