If the quantity of money grows at 3 percent per year, velocity does not grow, and real GDP grows at 2 percent per year, then the inflation rate equals
A) 6 percent.
B) 5 percent.
C) 1 percent.
D) -1 percent.
E) 12 percent.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, the equation for inflation is MV = PY, where M is the quantity of money, V is velocity, P is the price level, and Y is real GDP. If we assume that velocity (V) does not change, we can simplify the equation to M/P = Y/V. Solving for inflation (P₂ - P₁) / P₁, we get (M₂ - M₁) / (P₁*V), where M₂ and M₁ are the quantity of money in years 2 and 1, respectively. Plugging in the given values, we get (0.03 - 0) / (0.02*1) = 1.5 = 0.015 or 1.5%. Therefore, the inflation rate equals 1 percent.

If the Quantity of Money Grows at 3 Percent Per