Question

According to the quantity theory of money, If the central bank performs open market purchases,

a. The money supply increases, whereas the economy's ability to supply goods and services declines

b. The money supply decreases, whereas the economy's ability to supply goods and services does not change

c. Both the money supply and the economy's ability to supply goods and services increase

d. The money supply increases, whereas the economy's ability to supply goods and services does not change

Answer 1

Q. According to the quantity theory of money, If the central bank performs open market purchases:

Ans. c) Both the money supply and the economy's ability to supply goods and services increase.

When the central bank performs open market purchases, it increases the reserves of commercial banks and allow them to increase their loans and investments; increasing the price of government securities and effectively reducing the interest rate and hence promoting investment. This increases the economy's ability to supply goods and services.