If the aggregate price level doubles:
A) the money supply will also double.
B) neither money demand nor the money supply will rise.
C) both money demand and the money supply will rise proportionally.
D) money demand at any given interest rate will also double.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, the equation of exchange (MV = PQ) shows that a doubling of the price level (P) corresponds to a doubling of nominal GDP (PQ). Assuming that the velocity of money (V) remains constant, this means that the money supply (M) must also double to accommodate the increased demand for money needed to carry out the higher level of transactions. However, the demand for money (as measured by the quantity of money people want to hold for transactions and speculative purposes) is not directly affected by changes in the aggregate price level. Therefore, option A and C are incorrect. Option B is also incorrect as a doubling of the price level requires a doubling of the money supply, and the demand for money may rise to accommodate this increase. Option D is correct as a doubling of the price level means that people need to hold twice as much real money balances to make transactions, meaning that at any given interest rate, the demand for nominal money balances will double.

If the Aggregate Price Level Doubles