Question

Statistics

Posted 4 months ago

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According to the quantity theory of money, what happens if the money supply increases by $10 \%$ if the current rate of unemployment is equal to the natural rate of unemployment?
Choose 1 answer:
(A) The price level increases by $5 \%$ and real output increases by $5 \%$
(B) Real output increases more than the increase in the price level
(C) Real output increases $10 \%$
(D) Real output and the velocity of money both increase
() The price level increases by $10 \%$
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Answer from Sia

Posted 4 months ago

Solution by Steps

step 1

According to the quantity theory of money, the equation is given by $MV = PY$, where $M$ is the money supply, $V$ is the velocity of money, $P$ is the price level, and $Y$ is the real output

step 2

When the current rate of unemployment is equal to the natural rate of unemployment, the economy is at full employment, meaning that real output $Y$ is at its potential level and does not change with changes in the money supply

step 3

Given that $V$ (velocity of money) is constant, an increase in the money supply $M$ by 10% will lead to a proportional increase in the price level $P$ by 10%, since $Y$ remains unchanged

Answer

E

Key Concept

Quantity Theory of Money

Explanation

According to the quantity theory of money, if the money supply increases by 10% and the economy is at full employment (natural rate of unemployment), the price level will increase by 10% while real output remains unchanged.

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