Consider the money demand function that takes the form (M/P)d = kY, where M is the quantity of money, P is the price level, k is a constant, and Y is real output. If the money supply is growing at a 10 percent rate, real output is growing at a 3 percent rate, and k is constant, what is the average inflation rate in this economy?
A)3 percent
B)7 percent
C)10 percent
D)13 percent

Question

Quizplus · Accepted Answer

According to the quantity theory of money, the inflation rate (π) can be calculated as π = growth rate of money supply (gM) − growth rate of real output (gY) − constant (k). Plugging in the given values, we get π = 10% − 3% − k. Since k is not given, we cannot calculate the exact inflation rate, but we know that it will be less than 7% (10% − 3% = 7% being the upper bound). Therefore, the best choice is B, which is the closest option to 7%.

Consider the Money Demand Function That Takes the Form (M/P)d