Suppose the velocity of money is 6, the amount of money in circulation is $600 billion, the index of prices is 180, and real GDP is $20 billion. According to the strict quantity theory of money, if the money supply decreased to $300 billion,
A) the velocity of money would rise to 12.
B) the index of prices would fall to 90.
C) real GDP would decrease to $10 billion.
D) the velocity of money would decline to 3.

Question

Quizplus · Accepted Answer

According to the strict quantity theory of money, M*V=P*Y, where M is the money supply, V is the velocity of money, P is the index of prices, and Y is real GDP. Solving for P, we get P=M*V/Y. In this case, when M=$600 billion, V=6, P=180, and Y=$20 billion, we can solve for V by rearranging the formula to V=P*Y/M. Thus, V=180*$20 billion/$600 billion=6.

If M decreased to $300 billion, then according to the quantity theory of money, we can assume that V and Y would stay the same, since they are determined by factors other than the money supply. Given that V=6 and Y=$20 billion, we can solve for the new P using the formula P=M*V/Y. Thus, P=$300 billion*6/$20 billion=90. Therefore, the index of prices would fall to 90 if the money supply decreased to $300 billion.

Suppose the Velocity of Money Is 6, the Amount of Money