Question

As a result of Spanish conquest in Central and South America in the 1500s, a tremendous amount of gold became
available in Europe. Gold was an important form of money in Europe at this time.
Use the quantity theory of money to identify the circumstance under which a large influx of gold would [a] cause
inflation in Europe during the 1500s, and [b] not cause inflation in Europe during the 1500s.

Answer 1

As per the quantity theory of money,

MV = PQ

Where,

M is money supply

V is velocity

P is price level

Q is GDP or production of output

As gold supply increases, it is equivalent to an increase in money supply since gold is an important component of money.

As M increases, keeping V and Q constant, as per the quantity theory of money, P will also increase. This means price level in the economy would increase, leading to an increase in general inflation in the economy.

Thus, correct option: (a) cause inflation in Europe during the 1500s