Assume there is only one good in the economy, corn. The economy has enough labor, capital, and land to produce 1,800 bushels of corn. V is constant. In 2023, money supply was $3,600 and the price of corn was $8/bushel. For 2024, the Fed increases money supply, MS by 10%. The inflation is

Question

Assume there is only one good in the economy, corn. The economy has enough labor, capital, and land to produce 1,800 bushels of corn. V is constant.  In 2023, money supply was $3,600 and the price of corn was $8/bushel. For 2024, the Fed increases money supply, MS by 10%.  The inflation is

BlackTom AI · Accepted Answer

We start by understanding the setup: there is only one good (corn), and money supply (M) grows by 10% from 2023 to 2024. The velocity of money (V) is constant and total output (Y) is constrained by available resources to 1,800 bushels. In 2023, M = 3,600 and the price of corn P = 8, so nominal GDP P·Y = 8 × 1,800 = 14,400. With V constant, the quantity theory of money MV = PY implies that if M rises by 10% and V stays the same, then PY must also rise by 10% in 2024.

- Since Y is fixed at 1,800 bushels in the short run by resource constraints, the increase must come from a higher price level P.

- New money supply M' = 3,600 × 1.10 = 3,960. With V constant and Y unchanged, PY must be 10% higher than before: PY' = 14,400 × 1.10 = 15,840.

- Solving for P' given Y = 1,800: P' = PY' / Y = 15,840 / 1,800 = 8.8.

Now evaluate the answer choices:
- Option 1: 10. This corresponds to a 10% inflation rate, which matches the 10% rise in the price level calculated above. It is consistent with the quantity theory given the assumptions.
- Option 2: 8.80. This is the calculated new price level, not the inflation rate itself. If the base price was 8, the inflation rate would be (8.8 − 8) / 8 = 0.10 = 10%, not 8.8%.
- Option 3: 1.5. This would imply a very small inflation rate of 1.5%, which does not align with the 10% increase in money supply and the constant V with fixed output.
- Option 4: 8.12. This would imply a price level close to the original, indicating an inflation of about 1.5% if taken as the new price; but the actual calculation shows the price must rise to 8.8, not 8.12, under the given assumptions.

In summary, under the quantity theory with V constant and output fixed by capacity, a 10% money-supply increase translates into a 10% rise in the price level, i.e., inflation of 10%. The other options either confuse the new price level with the inflation rate or rely on incorrect implications about how P would adjust when M expands and Y is fixed.

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