TutorOn by Sanath Withanage

Question:

According to the assumptions of the Quantity Theory of Money, if the money supply increases by 10%, then:
(1) nominal GDP would rise by 10% and real GDP would be unchanged.
(2) nominal GDP and real GDP would rise by 10%.
(3) nominal GDP would be unchanged but real GDP would rise by 10%.
(4) nominal GDP would be unchanged but the price level would rise by 10%.
(5) neither nominal GDP nor real GDP would change.

Correct Answer:

(1)

Answer Explanation:

The Quantity Theory of Money (MV = PY) assumes velocity (V) and real output (Y) are constant in the short run. A 10% increase in the money supply (M) leads directly to a 10% increase in prices (P). Since Nominal GDP = P * Y, Nominal GDP rises by 10%.

Topic: Inflation Year: 2023