Question

Answer the following questions on the quantity theory of money.

a) According to the quantity theory of money, what will happen to nominal GDP if the money supply increases by 5% and the velocity of money does not change?

b) What will happen to nominal GDP if, instead, the money supply decreases by 8% and the velocity does not change?

c) What will happen to nominal GDP if, instead, the money supply increases by 5% and the velocity decreases by 5%?

Answer 1

According to the quantity theory of money

% change in Velocity + % change in money supply = % change in Nominal GDP

a) Using the information,

5% + 0% = 5% change in Nominal GDP

Hence the nominal GDP rises by 5% if the money supply increases by 5% and the velocity of money does not change.

b) Using the information,

-8% + 0% = -8% change in Nominal GDP

Hence the nominal GDP falls by 5% if the money supply decreases by 8% and the velocity of money does not change

c) Using the information

5% - 5% = 0% change in Nominal GDP

Hence the nominal GDP does not change if, instead, the money supply increases by 5% and the velocity decreases by 5%