In an economy in which real output grows at an average rate of 3 percent per year,a 7 percent average rate of growth in the money supply would result in a(n):
A)inflation rate of 4 percent,if velocity of money in circulation is constant.
B)inflation rate of -4 percent,if velocity of money in circulation is constant.
C)$7 increase in the price level each year.
D)$7 decrease in the price level each year.
E)increase in the velocity of money in circulation.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV = PY, where M is the money supply, V is the velocity of money, P is the price level and Y is real output. Assuming velocity remains constant, M grows by 7% and Y grows by 3%, resulting in a combined increase in PY of 10%. Therefore, if V is constant, an inflation rate of 4% (10% - 3% = 7%) would result.

In an Economy in Which Real Output Grows at an Average