Answer to Question 2:

The consumer price index in a particular economy increased from 100 in 1975, the base period, to 330 in 2008. In 1975 the amount of money in circulation was $880,000 and in 2008 it was $3,000,000. What was the real money supply in 2008 in 1975 dollars?

1. $2,904,000.

2. $909,090,90.

3. $266,666,67.

4. None of the above.

Choose the correct answer.

The correct answer is 2. The real money supply in 2008 in 1975 dollars was
($3,000,000/330) x 100 = $909,090.90.

Let's work through this answer in detail. The consumer price index in 2008 was 330 whereas in 1975 it was 100. The price level thus increased by the factor 3.3. If we divide $3,000,000 by 3.3, we get the correct answer. If we divide by 330, we must multiply the result by 100 to get the scale of the real money stock correct. We deflate the nominal money supply by the price index.

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