Suppose the velocity of money is 8, the amount of money in circulation is $200 billion, the index of prices is 150, and real GDP is $10 billion. According to the strict quantity theory of money, if the money supply doubled to $400 billion,
A) the velocity of money would fall to 4.
B) the index of prices would increase to 300.
C) real GDP would increase to $20 billion.
D) the velocity of money would rise to 16.

Question

Quizplus · Accepted Answer

The strict quantity theory of money states that MV=PQ, where M is the money supply, V is the velocity of money, P is the index of prices, and Q is real GDP. If we double the money supply to $400 billion, and assume that V and Q remain constant, then we can solve for the new index of prices as follows:

MV=PQ
(8)(200 billion)=(P)(10 billion)
P=150

Now, if we double the money supply to $400 billion, we can solve for the new index of prices:

MV=PQ
(16)(200 billion)=(P)(10 billion)
P=300

Therefore, the index of prices would increase to 300, which is answer choice B.

Suppose the Velocity of Money Is 8, the Amount of Money