According to the quantity theory of money, if output is higher, ______ real balances are required, and for fixed M this means ______ P.
A) higher; lower
B) lower; higher
C) higher; higher
D) lower; lower

Question

Quizplus · Accepted Answer

According to the quantity theory of money, if output is higher, higher real balances are required to facilitate the transactions of the increased output. For fixed M (money supply), an increase in real balances (B) results in a decrease in P (price level) according to the equation of exchange (M*V=P*T, where V is velocity of money and T is the value of transactions). Therefore, higher output requires higher real balances, which leads to lower price levels.

According to the Quantity Theory of Money, If Output Is