Average prices in Canukada are 200, real GDP is 300 and the money supply is 500. The quantity theory of money suggests that an increase in the money supply to 600 leads to average prices of 240.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, an increase in the money supply would lead to a proportional increase in prices. In this case, the initial price level was 200, real GDP was 300, and the money supply was 500. Using the equation of exchange, M*V = P*Y, where M is the money supply, V is the velocity of money, P is the price level, and Y is real GDP, we can solve for the new price level with the new money supply of 600: P = (M*V)/Y = (600*V)/300 = 2V. Since we don't know the velocity of money, we can assume it remains constant, which means the new price level would be 2 times the initial price level, or 400. However, the question suggests that the new price level would be 240, which is a 20% increase from the initial price level, not a doubling. This implies that the velocity of money has decreased, or another factor is influencing the relationship between money supply and prices. Nonetheless, the statement that an increase in money supply to 600 leads to average prices of 240 is false according to the quantity theory of money.

Average Prices in Canukada Are 200, Real GDP Is 300