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3 February, 10:44

Suppose that the quantity of money in circulation is fixed but the income velocity of money doubles. If real GDP remains at its long-run potential level, what happens to the equilibrium price level?

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  1. 3 February, 13:12
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    The equilibrium price level will double.

    Explanation:

    Suppose that the economy has a money supply of $4 billion and the income velocity of money is 8, the price level will be 4 and the real GDP is $8 billion. The formula we are using is:

    Money supply x velocity = price level x real GDP

    If the money supply remains the same ($4 billion), the income velocity of money is 16 (it doubles), and the real GDP is $8 billion, then the price level will be:

    $4 x 16 = price level x $8

    $64 = price level x $8

    price level = $64 / $8 = 8

    So the price level has doubled to 8.
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