Question

c. If the velocity of money does not change, and the change in real GDP exactly keeps pace with the change in the money supply, what will happen to the price level (P)? Ensure to elaborate your answer. [5 MARKS]

Answer 1

The answer is that the price level will stay constant and does not change.

According to the quantity theory of money, we have:

MV = PY

where M is money supply, V is velocity of money, P is the price level, and Y is the output

=> % change in M + % change in V = % change in P + % change in Y

=> % change in M + 0 = % change in P + % change in Y (V is constant)

Now, if % change in M = % change in Y (from the question)

=> % change in P = 0

Thus, the price will not change