If the demand for money depends on the interest rate, then a ________ in the money supply will increase nominal GDP by ________.
A) 5% increase; more than 5%
B) 5% increase; less than 5%
C) 5% decrease; more than 5%
D) 5% decrease; exactly 5%

Question

Quizplus · Accepted Answer

According to the quantity theory of money, an increase in the money supply will lead to an increase in aggregate demand, which in turn will increase nominal GDP. However, the extent to which nominal GDP increases depends on the responsiveness of the demand for money to changes in the interest rate. If the demand for money is very sensitive to changes in the interest rate, then a given increase in the money supply will lead to a smaller increase in nominal GDP. On the other hand, if the demand for money is relatively insensitive to changes in the interest rate, then a given increase in the money supply will lead to a larger increase in nominal GDP. Therefore, it is likely that an increase in the money supply will increase nominal GDP by less than 5%, but more than 0%. B is the closest option to this scenario.

If the Demand for Money Depends on the Interest Rate