Ased on the quantity theory of money, if velocity is constant, inflation is likely to occur when:

A. The money supply grows at a slower rate than real GDP.

B. The money supply grows at a faster rate than real GDP.

C. The money supply grows at the same rate as real GDP.

D. The money supply and inflation are unrelated.

Question

Angelina Mcpherson

Business

5 October, 15:15

Ased on the quantity theory of money, if velocity is constant, inflation is likely to occur when:

A. The money supply grows at a slower rate than real GDP.

B. The money supply grows at a faster rate than real GDP.

C. The money supply grows at the same rate as real GDP.

D. The money supply and inflation are unrelated.

+1

Answers (1)

Know the Answer?

Aryan · Answer 1

Option (B) is correct.

Explanation:

The quantity theory of money can be expressed in the form of an equation that is

M * V = P * GDP

where,

M = Money supply

V = Velocity of money

P = Price level

GDP = Gross domestic product

P * GDP is the nominal GDP, it is the amount of required for purchasing the total amount of output. All the transactions are depends upon the income level of the consumers at the full-employment level. So, if there is an increase in the money supply, this will results in higher prices which means that an increase in the money supply over the real gross domestic product would cause the inflation.

Increase in the money supply will increase the nominal GDP but real GDP remains the same. But if the growth rate of money supply is equal to the growth rate of real GDP then there will be no inflation and Real GDP remains constant at the full-employment level, hence, its level of volume doesn't increase if the there is an increase in the money supply.

Therefore, increased growth rate of money supply over the real GDP causes inflation.