Assuming the velocity of money and real GDP are fixed, the quantity theory of money predicts that a 2% increase in the money supply causes a 2%:
A) increase in inflation.
B) decrease in inflation.
C) increase in the average price level.
D) decrease in the average price level.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, the equation of exchange is MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is real GDP. Assuming V and Q are fixed, an increase in M will lead to an increase in P, or the average price level. Therefore, a 2% increase in the money supply will lead to a 2% increase in the average price level.

Assuming the Velocity of Money and Real GDP Are Fixed