If spending grows by 3%,real GDP grows by 5%,and velocity is stable,then prices will be _____ at a rate of _____ according to the aggregate demand curve.
A) falling;3%
B) falling;2%
C) rising;3%
D) rising;2%

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV = PY, where M is the money supply, V is velocity, P is the price level and Y is real GDP. Given that velocity is stable, we can assume that it remains constant. 
If spending grows by 3%, then MV will increase by 3%. If real GDP grows by 5%, then Y will also increase by 5%. 
Thus, 3% + 0% = P (inflation rate) + 5%. Simplifying, we get P = 2%. Therefore, prices will be falling at a rate of 2% according to the aggregate demand curve.

If Spending Grows by 3%,real GDP Grows by 5%,and Velocity