Chapter 15: Problem 26

If \(\mathrm{MV}\) rises, \(\mathrm{PQ}\) (LO1) a) must rise c) must stay the same b) may rise d) must fall

Short Answer

Expert verified

Based on the analysis of the Quantity Theory of Money, the correct answer is (b) PQ may rise, as it accounts for the possibility of other factors influencing the Price Level and Real Output in response to an increase in the Money Supply (MV).

Step by step solution

Understand the Quantity Theory of Money

The Quantity Theory of Money states that the money supply (M) times the velocity of money (V) is equal to the nominal value of all goods and services in the economy: MV = PQ, where P is the price level and Q is the real output. This equation forms the basis of our analysis.

Option a: PQ must rise

If MV rises and the relationship MV = PQ holds, then an increase in MV must also result in an increase in PQ. In this case, the price level (P), the real output (Q), or both may increase, depending on the economic conditions.

Option b: PQ may rise

In this option, the statement considers that an increase in MV may cause an increase in PQ. This implies that there might be other factors, such as economic conditions or government policies, influencing the Price Level and Real Output, and they might mitigate or even nullify the impact of a rise in MV.

Option c: PQ must stay the same

According to this option, an increase in MV would have no effect on PQ. This would imply that the relationship MV = PQ does not hold true, which contradicts the Quantity Theory of Money.

Option d: PQ must fall

This option suggests a negative relationship between MV and PQ, meaning that an increase in MV causes a decrease in PQ. However, this contradicts the Quantity Theory of Money, which indicates a positive relationship between MV and PQ.

Select the correct option

Based on the analysis of all four options, we can conclude that the correct option is (b) PQ may rise, as it accounts for the possibility of other factors influencing the Price Level and Real Output in response to an increase in the Money Supply (MV).

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