Consider the money demand function that takes the form (M/P)d=kY, where M is the quantity of money, P is the price level, k is a constant, and Y is real output. If the money supply is growing at a 10 percent rate, real output is growing at a 3 percent rate, and k is constant, what is the average velocity of money in this economy?
A)3 percent
B)7 percent
C)10 percent
D)13 percent

Question

Quizplus · Accepted Answer

The quantity theory of money states that MV=PY, where M is the quantity of money, V is the velocity of money, P is the price level, and Y is real output. If we assume that the quantity theory holds true, we can solve for V: V = (PY)/M = (kY)/M. Given the information provided in the question, we know that M is growing at a 10% rate and Y is growing at a 3% rate. Therefore, we can calculate the average velocity of money as (10% + 3%) / 2 = 6.5%. However, k is constant and not provided in the question, so we cannot calculate an exact answer. The closest answer choice is B, which is 7%.

Consider the Money Demand Function That Takes the Form (M/P)d=kY