CMA Foundation · Fundamentals of Business Economics and Management · Money and Banking
Assuming velocity of circulation and volume of transactions remain constant, what does the quantity theory of money predict if the money supply is doubled?
The price level doubles and the value of money halves. With velocity and transactions constant, the quantity theory makes prices directly proportional to money supply, and since the value of money is the inverse of the price level, it falls to half.
- AThe value of money doubles
- BThe price level doubles and the value of money halvesCorrect
- CThe price level remains unchanged
- DThe price level halves
Explanation
From MV = PT, with V and T fixed, P is proportional to M. Doubling M doubles P. The value of money is the reciprocal of the price level (1/P), so it falls to half. The option saying the value doubles reverses the relationship.
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