Question

Assume that velocity and aggregate output are constant. If the money supply increases from ​$1.10 trillion to ​$1.14 ​trillion: A. aggregate output will increase by 2.73​%. B. the price level will increase by 3.64​%. C. the price level will increase by 2.73​%. D. aggregate output will increase by 3.64​%.

Answer 1

Answer: Option (B) is correct.

Explanation:

Money supply changes from ​$1.10 trillion to ​$1.14 ​trillion

Percentage increase in money supply = $\frac{1.14 - 1.10}{1.10} \times100$

                                                                = 3.636%

                                                                = 3.64% (approx.)

According to the quantity theory of money,

Money supply × Velocity = Price × output

Velocity and aggregate output is constant and if there is an increase in the money supply by 3.64% then as a result price level also increases by 3.64%.