If velocity is growing by 2 percent per year and real output is growing 6 percent per year, according to the equation of exchange, in order to maintain stable prices, the money supply would have to:
A)grow by 3 percent.
B)grow by 4 percent.
C)grow by 8 percent.
D)grow by 12 percent.

Question

If velocity is growing by 2 percent per year and real output is growing 6 percent per year, according to the equation of exchange, in order to maintain stable prices, the money supply would have to:
A)​grow by 3 percent.
B)​grow by 4 percent.
C)​grow by 8 percent.
D)​grow by 12 percent.

Quizplus · Accepted Answer

According to the equation of exchange, MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is real output. 
To maintain stable prices, the growth rate of the money supply must match the inflation rate, which is equal to the growth rate of nominal GDP. 
Therefore, in this case, the nominal GDP growth rate is 6 percent and the velocity of money is growing at 2 percent. So, the required growth rate of the money supply would be:
6% = (growth rate of money supply) + 2%
(growth rate of money supply) = 4%
Thus, the money supply would have to grow by 4 percent per year to maintain stable prices.

If Velocity Is Growing by 2 Percent Per Year and Real