What is the basic idea of the quantity theory of money in relation to the MV=PY equation?

What is the basic idea of the quantity theory of money in relation to the MV=PY equation?

• A. If velocity and real output are stable, increasing money supply raises the price level; in the long run, MV may affect P.
• B. Velocity is the only determinant of the price level.
• C. The money supply has no effect on prices in the long run.
• D. Output is determined entirely by the money supply.

Answer: (A)

The basic idea here is that MV = PY ties the money stock, its velocity, the price level, and real output together. If velocity (V) and real output (Y) are stable, increasing the money supply (M) drives up nominal spending (M×V). With Y fixed in the short run, more money chasing the same amount of real goods pushes up the price level (P). Over time, changes in the money supply mainly show up as changes in the price level rather than in real output, so the long-run effect is on prices as the economy adjusts. That’s why this option is the best: it captures that increasing M raises P when V and Y are stable, and that, in the long run, changes in the money stock affect the price level. The other statements misstate the role of money, velocity, and output in determining prices.

The basic idea here is that MV = PY ties the money stock, its velocity, the price level, and real output together. If velocity (V) and real output (Y) are stable, increasing the money supply (M) drives up nominal spending (M×V). With Y fixed in the short run, more money chasing the same amount of real goods pushes up the price level (P). Over time, changes in the money supply mainly show up as changes in the price level rather than in real output, so the long-run effect is on prices as the economy adjusts.

That’s why this option is the best: it captures that increasing M raises P when V and Y are stable, and that, in the long run, changes in the money stock affect the price level. The other statements misstate the role of money, velocity, and output in determining prices.