The quantity theory of money predicts that
A) in the short run, a 10 percent increase in the quantity of money leads to a 10 percent increase in velocity.
B) in the long run, a 10 percent increase in the quantity of money leads to a 10 percent increase in velocity.
C) in the long run, a 10 percent increase in the quantity of money leads to a 10 percent increase in real GDP.
D) in the long run a 10 percent increase in the quantity of money leads to a 10 percent increase in the price level.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, in the long run, a change in the quantity of money will lead to a proportional change in the price level. This is expressed by the equation of exchange: MV=PY, where M is the money supply, V is velocity (the rate at which money changes hands), P is the price level, and Y is real GDP. Assuming that real GDP does not change with the change in the money supply, a 10 percent increase in M will result in a 10 percent increase in PY, which can only be achieved by a 10 percent increase in P. Therefore, the correct answer is D.

The Quantity Theory of Money Predicts That