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 the velocity of money in circulation is constant.
B) inflation rate of -4 percent, if the 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

The equation of exchange states that MV=PQ, where M is the money supply, V is the velocity of money in circulation, P is the price level, and Q is the quantity of goods and services produced. Assuming that the velocity of money is constant, an increase in the money supply will result in a proportional increase in the price level. Therefore, a 7 percent growth in the money supply would result in a 7 percent increase in the price level, and combined with the 3 percent growth in real output, would lead to an inflation rate of 4 percent (7 percent - 3 percent = 4 percent).

In an Economy in Which Real Output Grows at an Average