The quantity equation tells us that, in the long run, when the economy is at potential GDP, an increase in the growth of the money supply will
A)always increase inflation by the same amount if velocity is constant.
B)increase inflation by a smaller amount if velocity increases.
C)increase inflation by a larger amount if velocity decreases.
D)always increase inflation.
E)have no effect on inflation if velocity is constant.

Question

Quizplus · Accepted Answer

The quantity equation 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. In the long run, Y is fixed at potential GDP. Therefore, an increase in M will lead to an increase in P if V is constant. According to the quantity theory of money, the percentage increase in the price level is equal to the percentage increase in the money supply minus the percentage increase in real GDP. Therefore, an increase in the growth of the money supply will always increase inflation by the same amount if velocity is constant (choice A).

The Quantity Equation Tells Us That, in the Long Run