In the quantity theory of money, velocity means
Select one:
a. the rate of the change in GDP.
b. the rate at which business inventories turn over.
c. the rate at which the money supply turns over. Correct
d. the rate at which the Fed increases the money supply.
answer
c. Velocity refers to the speed at which the money supply turns over. Velocity plays a crucial role in the quantity theory of money because it is normally very stable. Its stability implies that inflation is caused by a change in the money supply.
question
Which of the following correctly expresses the quantity theory of money?
Select one:
a. money × the price level = velocity × real output
b. money × velocity = price level × real output
c. velocity × real output = price level × money
d. price level × velocity = real output
answer
b. The quantity theory of money says that the price level times real output is equal to the money supply times the velocity, or the number of times the money supply turns over. Velocity is generally stable. The implication for this fact is that increases in the money supply cause the price level to increase unless real GDP increases.
question
If the money supply increases by 10% and real GDP increases by 3%, prices will increase by
Select one:
a. more than 10%.
b. 10%.
c. 13%.
d. less than 10%.
answer
d. Although there is a 10% increase in the money supply, there is an increase in real GDP that partially compensates for the increase in money. Therefore the increase in prices would be something less than 10%. You can see this in the quantity equation M × V = P × Y.
question
The widely held belief that when the central bank creates money, prices rise is called
Select one:
a. NAIRU, or the natural rate of unemployment.
b. Okun's law.
c. the Friedman dilemma.
d. the quantity theory of money.
answer
d. The quantity theory of money states that inflation is always caused by too much money. When the Fed causes the growth rate of the money supply to increase faster than the potential increase in real GDP, the result is inflation.
question
The quantity theory of money can explain
Select one:
a. hyperinflation, but not moderate inflation.
b. moderate inflation, but not hyperinflation.
c. moderate inflation and hyperinflation, but not deflation.
d. moderate inflation, hyperinflation, and deflation.
answer
d. The quantity theory of money determines all the effects on prices and output due to changes in the money supply, holding the velocity of money constant.
question
The velocity of money is defined as
Select one:
a. the rate at which the Fed increases the money supply.
b. the rate at which money is being spent.
c. the average number of times per year a dollar changes hands.
d. the average number of times per year a dollar is spent on a consumer good.
answer
c. The velocity of money determines on average how many times a dollar is spent and re-spent in one year.
question
The quantity equation is written as M × Y = V × P.
Select one:
True
False
answer
False
The quantity equation is written as M × V = P × Y, where M is the money supply, V is the velocity of money, P is the price level, and Y is output.
question
Suppose the U.S. economy is experiencing a recession. Increasing the money supply will provoke an expansion.
Select one:
True
False
answer
True
In a recessionary economy, unemployment is high. Holding the velocity of money constant and increasing the money supply will cause an increase in production, income, and equilibrium GDP. This chain of events will cause a short-run expansion.
question
Increasing the money supply in an expanding economy will most likely cause
Select one:
a. an increase in equilibrium GDP.
b. an increase in the price level.
c. a decrease in the unemployment rate.
d. further economic expansion.
answer
b. Because unemployment is already low, increasing the money supply will only increase the price level and push the economy into a recession.
question
Assume the velocity of money is held constant. According to the classical view of money,
Select one:
a. changes in the money supply will affect either price or output.
b. output is fixed in the long run, so changes in the money supply will only affect the price level.
c. changes in the money supply will only affect output.
d. changes in nominal variables will only affect real variables.
answer
b. The classical view of money holds output constant in the long run and assumes the velocity of money is constant. So changes in the money supply will only affect the price level.
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