Suppose that a country's money supply grows at 15 percent per year and the velocity of money circulation remains constant. The country's real GDP grows at 4% and the nominal interest rate is 10%. Due to some external shock, a leftward shift in the short-run aggregate supply curve (SRAS) results in a 2 percent decline in the level of output. What were the growth rate of nominal GDP, the rate of inflation, and the real interest rate before the external shock? What is the new real GDP growth rate? What is likely to happen to nominal GDP and the inflation rate?A.19%, 10.58%, 0.58%; 2%; Nominal GDP decreases, inflation rate increases.B.19%, 10.58%, 0.58%; 2%; Nominal GDP increases, inflation rate increases.C.15%, 10.58%, -0.58%; 2%; Nominal GDP decreases, inflation rate increases.D.15%, 10.58%, -0.58%; 6%; Nominal GDP decreases, inflation rate decreases.SUBMIT ANSWER
Question
Suppose that a country's money supply grows at 15 percent per year and the velocity of money circulation remains constant. The country's real GDP grows at 4% and the nominal interest rate is 10%. Due to some external shock, a leftward shift in the short-run aggregate supply curve (SRAS) results in a 2 percent decline in the level of output. What were the growth rate of nominal GDP, the rate of inflation, and the real interest rate before the external shock? What is the new real GDP growth rate? What is likely to happen to nominal GDP and the inflation rate?A.19%, 10.58%, 0.58%; 2%; Nominal GDP decreases, inflation rate increases.B.19%, 10.58%, 0.58%; 2%; Nominal GDP increases, inflation rate increases.C.15%, 10.58%, -0.58%; 2%; Nominal GDP decreases, inflation rate increases.D.15%, 10.58%, -0.58%; 6%; Nominal GDP decreases, inflation rate decreases.SUBMIT ANSWER
Solution
The growth rate of nominal GDP can be calculated using the equation of exchange, MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is real GDP. If M grows at 15% and Y grows at 4%, and V is constant, then the growth rate of nominal GDP (PY) is 15% + 4% = 19%.
The rate of inflation can be calculated as the growth rate of nominal GDP minus the growth rate of real GDP, which is 19% - 4% = 15%.
The real interest rate is the nominal interest rate minus the inflation rate, which is 10% - 15% = -5%.
Before the external shock, the growth rate of nominal GDP was 19%, the rate of inflation was 15%, and the real interest rate was -5%.
After the external shock, the real GDP growth rate is 4% - 2% = 2%.
If the short-run aggregate supply curve shifts to the left, this means that at every price level, less output is being produced. This will likely lead to a decrease in nominal GDP, as the same amount of money is chasing fewer goods. The inflation rate is likely to increase, as the decrease in output leads to higher prices.
So, the correct answer is C.15%, 10.58%, -0.58%; 2%; Nominal GDP decreases, inflation rate increases.
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