Suppose that in the equation of exchange M = $1 trillion, V = 8, P = 1.0 and Q = $8 trillion. If the money supply is increased by $1 trillion, velocity is constant and the economy is at full employment then:
A) output will decrease to $4 trillion.
B) output will increase to $12 trillion.
C) output will increase to $16 trillion.
D) the price level will increase to 2.0.

Question

Quizplus · Accepted Answer

Given the equation of exchange MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is the output. Initially, M = $1 trillion, V = 8, P = 1.0, and Q = $8 trillion. If the money supply increases to $2 trillion (M = $2 trillion) and velocity (V) remains constant at 8, with the economy at full employment (meaning Q cannot increase), the entire effect of the increased money supply will be on the price level (P). The new equation becomes 2 trillion * 8 = P * $8 trillion. Solving for P gives P = 2.0, indicating that the price level will double to 2.0, reflecting inflation without an increase in output.

Suppose That in the Equation of Exchange M = $1