If the money supply rises from $600 billion to $800 billion and nominal GDP stays unchanged at $4,800 billion, then the income velocity of money
A) rises by 33 percent.
B) falls by 33 percent.
C) rises from 6 to 8.
D) falls from 8 to 6.

Question

Quizplus · Accepted Answer

The equation of exchange is MV = PY, where:

M = money supply
V = velocity of money
P = price level
Y = real GDP (or output)

From the given information, we know that:

M1 = $600 billion (original money supply)
M2 = $800 billion (new money supply)
PY = $4,800 billion (nominal GDP stays constant)

To find the change in velocity of money, we can rearrange the equation of exchange and solve for V:

V1 = PY/M1 = $4,800 billion / $600 billion = 8
V2 = PY/M2 = $4,800 billion / $800 billion = 6

Therefore, the income velocity of money falls from 8 to 6, or by approximately 25 percent [(8-6)/8 * 100% = 25%]. Thus, the correct answer is D.

If the Money Supply Rises from $600 Billion to $800