In an economy in which real output grows at an average rate of 3 percent per year,a 7 percent average rate of growth in the money supply would result in a(n)
A)inflation rate of 4 percent,if velocity were constant
B)inflation rate of -4 percent,if velocity were constant
C)$4 increase in the price level per year
D)$4 decrease in the price level per year
E)change in the velocity of money

Question

Quizplus · Accepted Answer

The quantity theory of money states that MV=PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is real output. Assuming velocity is constant, a 7 percent growth in the money supply (M) would result in a 7 percent growth in nominal output (PY). Since real output (Y) is growing at a 3 percent rate, the remaining 4 percent growth in nominal output must be attributed to inflation (P). Therefore, the inflation rate would be 4 percent.

In an Economy in Which Real Output Grows at an Average