Using the cash balance version of the quantity theory with k = .2, an increase in the money supply of $100 billion leads to an increase in GDP of
A) $500 billion.
B) $100 billion.
C) $50 billion.
D) $20 billion.

Question

Quizplus · Accepted Answer

The cash balance version of the quantity theory of money can be represented by the equation $MV = PY$, where $M$ is the money supply, $V$ is the velocity of money, $P$ is the price level, and $Y$ is the real GDP. The equation can also be rearranged to $M = kPY$, where $k = 1/V$ represents the proportion of nominal GDP people wish to hold in cash. Given $k = 0.2$, an increase in the money supply of $100 billion means that the GDP will increase by $100 billion / 0.2 = $500 billion, because $k$ represents the fraction of the GDP that the money supply can support.

Using the Cash Balance Version of the Quantity Theory with K