From the equation of exchange, if both nominal income and the quantity of money (M) triple, the price level (P) increases by 50 percent and velocity (V) remains constant, then real output (Y)________.
A) also triples
B) increases by 50 percent
C) doubles
D) decreases by 50 percent
E) none of the above

Question

Quizplus · Accepted Answer

According to the equation of exchange, MV = PY. If M and nominal income triple, then MV = 3M x 3Y = 9MY. Since V remains constant, we can set 9MY = V(P)(Y), which simplifies to 9M = P. Therefore, if M triples and P increases by 50%, then P must be equal to 1.5 times its original value, or P = 1.5(9M/3) = 4.5M/3. Solving for Y, we have Y = (MV)/P = (3M x 3Y)/ (4.5M/3) = 6Y, which implies that Y doubles. Therefore, the correct answer is C, which states that real output doubles.

From the Equation of Exchange, If Both Nominal Income and the Quantity