Question

M=$20,000 V=3 P=4 Q=$15,000

The Thain of the Shire increases the money supply by $5,000. Using the simple quantity theory of money above, what is the net effect of the increase in the money supply in this case? Use the actual numbers.

Answer 1

Quantity theory of money = Money supply (M) * Velocity of money (V) = Price level (P) * Output (Q)

= 20,000 * 3 = 4 * 15000

= 60,000 = 60,000

Quantity theory of money will remain equal from both sides always.

If money supply increased by $5000 , become total money supply $25,000

M * V = P * Q

25000 * 3 = P * 15000    Total output (Q) will remain same as 15000

P = 25000 * 3 / 15000

P = 75/15 = 5

So increasse in money supply by $5,000 will raise the price level from 4 to 5.

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