Question 1

The quantity theory of money assumes that:

Accepted Answer

The quantity theory of money assumes that velocity of money (the rate at which money is exchanged in transactions) remains constant in the short run. It also assumes that the level of output (income) is determined by the economy's productive capacity and the level of technology, and that changes in the money supply will translate proportionately into changes in prices. However, prices are not assumed to be constant in the theory. The money supply is also not assumed to be constant, as it is a key factor in the theory's prediction of changes in prices.

Question 2

The quantity equation, viewed as an identity, is a definition of the:

Accepted Answer

The quantity equation, viewed as an identity, defines the transactions velocity of money, which is the rate at which money circulates in the economy.

Question 3

Consider the money demand function that takes the form (M/P)^d = kY, where M is the quantity of money, P is the price level, k is a constant, and Y is real output. If the money supply is growing at a 10 percent rate, real output is growing at a 3 percent rate, and k is constant, what is the average inflation rate in this economy?

Accepted Answer

According to the quantity theory of money, the growth rate of nominal GDP (or the price level times real output) should be equal to the growth rate of the money supply minus the growth rate of money velocity (the inverse of the money demand function). In this case, we can rewrite the money demand function as P = kY(M/^d), and since k is constant, we can treat M/^d as a constant, say c. Therefore, P = ckY. Assuming money velocity is constant, the growth rate of nominal GDP is equal to the sum of the growth rates of real output and the price level, which we can write as: gP + gY = gM - gV where gP is the inflation rate, gY is the growth rate of real output, gM is the growth rate of the money supply, and gV is the growth rate of money velocity. We are given that gM = 10% and gY = 3%. We can assume that gV is roughly constant, so gP = gM - gY - gV. Since gM is greater than gY, inflation is positive. However, we do not have enough information to estimate gV, so we cannot calculate the exact inflation rate. However, we can make an educated guess that gV is small and roughly constant over time, which means that gP is roughly equal to gM - gY. This gives us an estimate of 10% - 3% = 7% for the average inflation rate in this economy. Therefore, the best answer is (B).

Question 4

According to the quantity theory of money, if money is growing at a 10 percent rate and real output is growing at a 3 percent rate, but velocity is growing at increasingly faster rates over time as a result of financial innovation, the rate of inflation must be:

Accepted Answer

According to the quantity theory of money, the inflation rate equals the growth rate of the money supply minus the growth rate of real output minus the growth rate of velocity. If money is growing at 10 percent and real output is growing at 3 percent, the growth rate of money minus the growth rate of real output is 7 percent. However, if velocity is growing at increasingly faster rates, it means people are spending their money faster, which puts upward pressure on prices. Therefore, the overall inflation rate will be increasing.

Question 5

If income velocity is assumed to be constant, but no other assumptions are made, the level of ______ is determined by M.

Accepted Answer

If income velocity is assumed to be constant and the level of M is known, then nominal GDP can be calculated using the equation MV = Py, where M is the money supply, V is the velocity of money, P is the price level, and y is real GDP. Therefore, the level of nominal GDP (which includes prices, income, and transactions) is determined by M.

Question 6

If the demand for real money balances is proportional to real income, velocity will:

Accepted Answer

If the demand for real money balances is proportional to real income, it means that as real income increases, the demand for real money balances increases at the same rate, keeping the velocity of money (the rate at which money circulates in the economy) constant. Velocity is defined as the ratio of nominal GDP to the money supply, and if both the numerator (nominal GDP, which reflects real income) and the denominator (money supply, which reflects real money balances) increase proportionally, the velocity remains unchanged.

Question 7

When the demand for money parameter, k, is large, the velocity of money is ______ and money is changing hands ______

Accepted Answer

When the demand for money parameter, k, is large, it means that people want to hold onto their money for longer periods, leading to a smaller velocity of money as it changes hands less frequently.

Question 8

If the quantity of real money balances is kY, where k is a constant, then velocity is:

Accepted Answer

Velocity (V) is defined as the ratio of nominal output (PY) to the quantity of real money balances (M/P). So, V = PY/(M/P), which can be simplified to V = kY/(M/P) = (kY/P)/(M/P) = (k/P)(Y/M). Since k is a constant, Y/M is the inverse of the quantity of real money balances (M/Y), which is also known as the velocity of money. Therefore, V = (k/P)(1/(M/Y)) = 1/k.

Question 9

In the long run, according to the quantity theory of money and the classical macroeconomic theory, if velocity is constant, then ______ determines real GDP and ______ determines nominal GDP.

Accepted Answer

According to the quantity theory of money and classical macroeconomic theory, the productive capability of the economy determines real GDP, while the money supply determines nominal GDP, assuming velocity is constant.

Question 10

If the transactions velocity of money remains constant while the quantity of money doubles, the:

Accepted Answer

The equation of exchange, MV = PQ, where M is the quantity of money, V is the velocity of money, P is the price level, and Q is the quantity of transactions, implies that if M doubles and V remains constant, then PQ (the price of the average transaction multiplied by the number of transactions) must also double.

Question 11

The definition of the transactions velocity of money is:

Accepted Answer

The transactions velocity of money is defined as the rate at which money circulates in the economy, calculated as the total nominal amount of transactions (prices multiplied by transactions) divided by the total money supply.

Question 12

The income velocity of money increases and the money demand parameter k ______ when people want to hold ______ money.

Accepted Answer

The answer of The income velocity of money increases and...

Question 13

The rate of inflation is the:

Accepted Answer

The rate of inflation is defined as the percentage change in the overall level of prices. It measures the extent of increase in the price level of goods and services over a certain period of time.

Question 14

Real money balances equal the:

Accepted Answer

Real money balances refer to the purchasing power of the money supply, meaning the amount of goods and services that can be purchased with the money available. This is distinct from nominal money balances, which simply count the total amount of money in circulation without accounting for changes in price levels or purchasing power.

Question 15

The transactions velocity of money indicates the _____ in a given period, while the income velocity of money indicates the _____ in a given period.

Accepted Answer

The transactions velocity of money refers to the number of times a unit of currency changes hands in a given period, whereas the income velocity of money refers to the number of times a unit of currency enters someone's income in a given period.

Question 16

If the average price of goods and services in the economy equals $10 and the quantity of money in the economy equals $200,000, then real balances in the economy equal:
A) 10.
B) 20,000.
C) 200,000.
D) 2,000,000.

Accepted Answer

The answer of If the average price of goods and...

Question 17

According to the quantity theory of money, ultimate control over the rate of inflation in the United States is exercised by:

Accepted Answer

According to the quantity theory of money, inflation is caused by an increase in the supply of money. Therefore, the entity that has control over the supply of money has the ultimate control over the rate of inflation. In the United States, the Federal Reserve is responsible for setting monetary policy and controlling the money supply. Therefore, the Federal Reserve has ultimate control over the rate of inflation.

Question 18

The income velocity of money:

Accepted Answer

The income velocity of money is defined in the identity MV = PY, where M is the money supply, V is the velocity, P is the price level, and Y is the real GDP.

Question 19

If velocity is constant and, in addition, the factors of production and the production function determine real GDP, then:

Accepted Answer

Given constant velocity and the determination of real GDP by factors of production and the production function, the price level varies directly with the money supply according to the Quantity Theory of Money (MV = PY).

Question 20

The quantity equation for money, by itself:

Accepted Answer

The quantity equation for money is MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is real GDP. By rearranging the equation, V = PY/M, it defines the velocity of money as the ratio of nominal GDP (PY) to the money supply (M).

Quiz 5: Inflation: Its Causes, Effects, and Social Costs