Question

# 1. Using the quantity equation, what happens to the price level if the money supply increases...

1. Using the quantity equation, what happens to the price level if the money supply increases by 10%, velocity is constant, and real GDP does not change?

2. Using the quantity equation, what happens to the price level if the money supply increases by 10%, velocity is constant, and real GDP increases by 5%?

The quantity theory of money is as follows -

M * V = P * Y

M = Money Supply

V = Velocity

P = Price Levels

Y = GDP

The equation can also be represented as "sum of growth rate" for the variables.

M + V = P + Y

M = 10% ; V = 0% ; Y = 0%

Or,

10 + 0 = P + 0

Or,

P = 10%

Therefore, when money supply increases by 10% and real GDP does not change, price level increases by 10%

M = 10% ; V = 0% ; Y = 5% ;

Or,

10 + 0 = 5 + P

Or,

P = 5%

Therefore, when money supply increases by 10% and real GDP by 5%, the price level increases by 5%.

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