Suppose the money supply increases when there is much idle capacity in the economy.Which of the following will be the major contributor to the consequent rise in nominal GDP?
A) increases in velocity
B) increases in real output
C) increases in the price level
D) increases in the interest rate

Question

Suppose the money supply increases when there is much idle capacity in the economy.Which of the following will be the major contributor to the consequent rise in nominal GDP?  
A) increases in velocity 
B) increases in real output 
C) increases in the price level 
D) increases in the interest rate

Quizplus · Accepted Answer

When there is much idle capacity in the economy, increasing the money supply will lead firms to increase production to meet the excess demand. This will result in an increase in real output and hence an increase in nominal GDP. Increases in velocity (A) may have some impact, but ultimately it is the increase in real output that will lead to the rise in nominal GDP. Increases in the price level (C) are not necessary as the increase in real output can absorb the increase in money supply without a significant rise in prices. Increases in the interest rate (D) may not be directly related and may actually decrease due to the increased demand for credit by firms.

Suppose the Money Supply Increases When There Is Much Idle