According to the assumptions of the quantity theory of money, if the money supply increases by 5 percent, then[Fill in the blank]

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BlackTom AI · Accepted Answer

Consider the question: according to the quantity theory of money, if the money supply increases by 5 percent, then what happens to nominal and real GDP?
Option a: 'nominal GDP would rise by 5 percent; real GDP would be unchanged.' This aligns with the basic quantity theory identity MV = PY, where if velocity (V) is stable and real GDP (Y) is determined by real factors in the short run, a rise in money supply (M) by 5% leads to a 5% increase in nominal GDP (P×Y) while real GDP (Y) remains unchanged.
Option b: 'nominal GDP would be unchanged; real GDP would rise by 5 percent.' This contradicts the standard implication since an increase in money supply typically elevates nominal spending, not leaves it unchanged, and real GDP would not automatically rise by 5% simply due to more money.
Option c: 'neither nominal GDP nor real GDP would change.' This would be the case only if the money illusion or other offsets occurred (e.g., velocity falling exactly to offset M), but under the simple quantity theory with V held constant, both prices and real output would not both stay fixed in the face of money growth; nominal GDP would respond.
Option d: 'nominal and real GDP would rise by 5 percent.' This would require real GDP to respond identically to the money growth in a way that exactly mirrors M, which is not the standard interpretation of the classical quantity theory where only nominal variables adjust when V and real factors are assumed constant.
In summary, the most consistent reading with the quantity theory of money under the usual (short-run) simplifications is that an M (+5%) shift raises nominal GDP by 5% via higher price level, while real GDP stays the same. Therefore, option a is correct, and the other options misstate how nominal and real GDP respond when the money supply changes.

According to the assumptions of the quantity theory of money, if the money supply increases by 5 percent, then[Fill in the blank]

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