According to the growth version of the quantity equation, if the money supply increases by 10 percent while velocity stays constant and real GDP increased by 2 percent, then the price level:
A) increased by 12 percent.
B) increased by 8 percent.
C) decreased by 8 percent.
D) decreased by 12 percent.

Question

Quizplus · Accepted Answer

According to the growth version of the quantity equation, MV=PQ, where M is the money supply, V is velocity, P is the price level, and Q is real GDP. If we assume that velocity is constant, then we can simply use the equation M/P=Q/V. In this case, if the money supply increases by 10 percent and real GDP increases by 2 percent, then we can solve for P:

(M/P) x (1.10) = (Q/V) x (1.02)

Solving for P, we get:

P = (M/P) x (1.10) x (V/Q) x (1/1.02)

Since V/Q is assumed constant, we can simplify this to:

P = (M/P) x (1.10/1.02)

If we plug in our values, this gives us:

P = (1.10/1) x (1.10/1.02)

P = 1.07843

Therefore, the price level increases by approximately 7.84 percent, or 8 percent (rounded to the nearest percent). The correct answer is B.

According to the Growth Version of the Quantity Equation, If