Question

Which of the following statements is NOT correct in the context of quantity theory of money?

• A. The quantity of money available determines the price level in the economy.
• B. The growth rate in the quantity of money available determines the inflation rate in the economy.
• C. The velocity of money must rise with the increase in the quantity of money in the economy.
• D. The economy's output is determined by factor supplies and technology, because money is neutral.

Answer 1

The Correct Option is C

The question tests your understanding of the quantity theory of money, a fundamental concept in macroeconomics. The quantity theory of money is primarily expressed by the equation:

MV = PT

where:

• M is the money supply
• V is the velocity of money
• P is the price level
• T is the number of transactions or real output

Let's evaluate each statement:

1. The quantity of money available determines the price level in the economy.
   This statement is correct. According to the equation, if assuming V and T are constant, any increase in M will increase P proportionally.
2. The growth rate in the quantity of money available determines the inflation rate in the economy.
   This is also correct. Inflation is often observed when there is sustained increase in M, assuming V and T are constant.
3. The velocity of money must rise with the increase in the quantity of money in the economy.
   This statement is not correct. The equation indicates that V, T, and P are independent of M; hence, V does not necessarily have to increase when M increases.
4. The economy's output is determined by factor supplies and technology, because money is neutral.
   This statement is correct and reflects the classical dichotomy and neutrality of money, which suggests that real variables, unlike nominal variables, are not affected by the money supply in the long run.

Based on the above analysis, the correct answer is: The velocity of money must rise with the increase in the quantity of money in the economy. This is the only statement that does not align with the tenets of the quantity theory of money.