If the money supply grows 5 per cent, and real output grows 2 per cent, prices should rise by
A) 5 per cent.
B) More than 5 per cent.
C) Less than 5 per cent.
D) None of these answers.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is real output. If the money supply grows 5 per cent and real output grows 2 per cent, and we assume that velocity is constant, then prices should rise by approximately 3 per cent, which is less than the 5 per cent increase in the money supply. Therefore, choice C is the best answer.

If the Money Supply Grows 5 Per Cent, and Real