Question

The quantity theory of money would argue that which of the following is generally responsible for decreases in prices (i.e., deflation)?

a. Money going down
b. Velocity going up
c. Money going up
d. Output going down

Answer 1

According to the Quantity Theory of Money, decreases in the money supply are generally responsible for deflation, as represented by the equation M*V = P*Y, where a decrease in M while V and Y are constant leads to a decrease in P.

Step-by-step explanation:

The Quantity Theory of Money would argue that a general decrease in prices, or deflation, is typically associated with a decrease in the money supply. This theory is based on the equation of exchange, which states that the product of the money supply (M) and its velocity (V) is equal to the nominal GDP, which is the product of the price level (P) and output (Y), expressed as M*V = P*Y.

In the scenario where the price level is dropping (indicating deflation), without changes in velocity or output, it would suggest that the money supply (M) is going down. A growth in money supply or fall in output could cause inflation, however, the theory also acknowledges that a significant change in velocity could cause fluctuations in nominal GDP.