In 2010, the money supply, M1, was $1,832 billion.

Nominal GDP was $14,660 billion.

a. What was the velocity of money measured using M1?

b. In 2010, M2 was $8,816 billion. What was the velocity of money measured using M2?

c. Why are these measures of velocity different?

In 2010, the money supply, M1, was $1,832 billion. Nominal GDP was $14,660 billion. We know that the relationship between money supply, the price

level, real GDP and the velocity of money is given by, M*V=PY, where M is the money supply, P is the price level, Y is

the real GDP and V is the velocity of money. We also know that nominal GDP=P*Y, i.e. it is real GDP evaluated

at current prices. Velocity of money is the frequency or number of transactions in

which the same dollar is used or circulated in a given period of time. a. What was the velocity of money measured using M1? Therefore using M1, We have, V=PY/M = PY/M1 = 14660/1832 = 8.002 =8 (approx.) b. In 2010, M2 was $8,816 billion. What was the velocity of

money measured using M2? Using M2,…

the velocity of money is, V =PY/M =PY/M2 = 14660/8816

= 1.6628 =1.66 (approx.) c. Why are these measures of velocity different? The definition of M2 is

much more wider than the definition of M1. Hence money supply as per M2 will be

higher than that under M1. Since there is more money under the definition of

M2, i.e. in other words there are more dollars used for transactions, the

number of times the same dollar is used for transactions in a given period of

time will be lower under M2 than under M1.