According to the quantity theory of money, if an economy produces 100 units of output and has a money supply equal to $500, then if the money supply doubles while velocity remains constant, the new price level will:
A) fall to half its initial level.
B) fall, but it will not fall all the way to half its initial level.
C) increase, but it will not double.
D) double.
E) more than double.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is the level of real output. Since V is constant, if M doubles, then PQ must also double. Since Q is fixed at 100 units of output, P must double in order for PQ to double. Therefore, the new price level will double.

According to the Quantity Theory of Money, If an Economy