The price level equals 4, the real GDP is $6 trillion in base-year dollars, and income velocity of money is 12. Then the money supply increases by $200 billion, while real GDP and income velocity of money remain unchanged. According to the quantity theory of money and prices, calculate the new price level after the increase in money supply Calculate the percentage increase in money supply Calculate the percentage change in the price level The percentage changes in the money supply is percentage changes in the price level. (pick one from below) less than the greater than the equal to the

The correct answer is "The percentage changes in the money supply is equal to the percentage changes in the price level" according to the equation of exchange

Explanation:

The Equation of Exchange deals with the relationship between money and price level, and also between money and real GDP.

The equation simply states:   M x V = P x Y

Where M = the money supply

           V = the velocity of money

           P = the price level

           Y = real GDP

Velocity is the number of times the average dollar is spent to buy final goods and services in a given year.  

Velocity can be calculated by using V = (P x Y ) / M

The equation tells us that total spending (M x V) is equal to total sales revenue (P x Y).

Since (P x Y) is equal to the real GDP, then M x V = real GDP

Velocity (V) and Real GDP (Y) are effectively constant in the short run, therefore any changes in money supply (M), will cause a proportional change in the price level (P).

This equation demonstrated a direct relationship between price and money supply. If V and Y are constant, a certain percentage change in money supply will cause an equal amount of change in the price level.

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