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QUESTION 12 In an economy in which real output grows at an average rate of 3...

QUESTION 12

In an economy in which real output grows at an average rate of 3 percent per year, a 7 percent average rate of growth in the money supply would result in a(n): a. $7 decrease in the price level each year. b. inflation rate of 4 percent, if the velocity of money in circulation is constant. c. increase in the velocity of money in circulation. d. inflation rate of -4 percent, if the velocity of money in circulation is constant. e. $7 increase in the price level each year.

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Answer #1

(12) According to Quantity Theory of Money.

M * V = P * Y

Where, M is the money supply.

V is the velocity of money

P is the price level.

Y is the real GDP.

In terms of growth:

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

We assume that there is constant velocity of money. So the % change in V would be zero.

7 + 0 = % change in P + 3

% change in P = 7 - 3

% change in P = 4.

There would be an inflation rate of 4%, if the velocity of money in circulation is constant.

Answer: Option (B)

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