If the average price level increases 10 percent per year, and the velocity of money is 2, then the:
A) inflation rate is 10 percent.
B) inflation rate is 5 percent.
C) inflation rate is 2 percent.
D) inflation rate is 20 percent.

Question

Quizplus · Accepted Answer

The quantity theory of money states that MV=PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the level of real output. Assuming Y is constant in the short run, if the money supply (M) remains constant and the velocity of money (V) is 2, then any increase in the price level (P) will result in an equal percentage increase in nominal output (PY). Therefore, if the average price level (P) increases by 10 percent per year, then the inflation rate is also 10 percent.

If the Average Price Level Increases 10 Percent Per Year