If spending grows by 3%,real GDP growth is 0%,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

If spending (or the money supply) grows by 3%, real GDP growth is 0%, and velocity (the rate at which money circulates) is stable, then according to the equation of exchange (MV = PQ), where M is the money supply, V is velocity, P is the price level, and Q is the quantity of goods and services produced (real GDP), prices must rise to absorb the extra spending. Since real GDP growth is 0%, the entire 3% increase in spending translates into a 3% increase in the price level, assuming velocity is constant. This is a direct application of the Quantity Theory of Money.

If Spending Grows by 3%,real GDP Growth Is 0%,and Velocity