Question

Using monetary theory, one can show that the price level (index) in an economy is equal to:(a) the inflation rate minus the interest rate.(b) the average change in the level of trade over the past 5 quarters.(c) the velocity of money.(d) the ratio of the nominal supply of money to the demand for real balances.

Answer 1

Answer: d) the ratio of the nominal supply of money to the demand for real balances.

Explanation: The price level index in an economy is equal to the ratio of the nominal supply of money to the demand for real balances when applying the monetary theory. The monetary theory shows the relation between money and what it will buy (purchasing power of money) wit distinction made between real and nominal values. Real values are the values that have been adjusted for the price level. Real values show that the change in the money supply is the main driver in the changes in economic activity.