Suppose that in the equation of exchange M = $1 trillion, V = 6, P = 1.0 and Q = $6 trillion. If the money supply is increased by $1 trillion and V is constant, then:
A) both P and Q could increase.
B) the price level could increase to 2.0 if the economy is at full employment.
C) output could increase to $12 trillion assuming that the economy is not at full employment and can produce this level of output.
D) all of the above.

Question

Quizplus · Accepted Answer

The equation of exchange is MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is the quantity of goods and services produced (real GDP). If the money supply increases from $1 trillion to $2 trillion while V remains constant, the right side of the equation (PQ) must also double to maintain equality. This means that both the price level (P) and the quantity of goods and services produced (Q) could increase, depending on the economic conditions such as whether the economy is at full employment or not. If the economy is at full employment, increases would primarily be in P, leading to inflation. If the economy is not at full employment, increases could be in Q without causing inflation. Therefore, all of the statements A, B, and C are possible outcomes, making D the correct answer.

Suppose That in the Equation of Exchange M = $1