If the income elasticity of money demand is 3/4,income increases 8%,and real money supply increases 10%,by about how much does the price level change?

Question

Quizplus · Accepted Answer

With an income elasticity of 3/4 and an 8% increase in income, the demand for real money supply will increase by (3/4) * 8% = 6%. However, the real money supply has increased by 10%, exceeding the increase in demand. This will lead to a slight increase in the price level. Using the quantity theory of money equation, M x V = P x Y, we can assume that V and Y are constant in the short run. The increase in M (10%) will cause an increase in P by approximately 10% - 6% = 4%. Therefore, the correct answer is C, a 4% rise in the price level.

If the Income Elasticity of Money Demand Is 3/4,income Increases