According to the quantity theory of money, if the money supply is growing at a rate of 5 percent, real GDP is growing at a rate of 2 percent, and velocity is constant, what will the inflation rate be?
What will be an ideal response?
Using the growth rate version of the quantity equation, we have:
growth rate of the price level (or inflation rate) = growth rate of money + growth rate of velocity - growth rate of real output.
If velocity does not change, then the growth rate of velocity is zero. Then:
growth rate of the price level (or inflation rate) = growth rate of money - growth rate of output.
Substituting in our values:
growth rate of the price level (or inflation rate) = 5 percent - 2 percent = 3 percent.
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What will be an ideal response?
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