Final answer:
In the context of the equation of exchange, if both the velocity of money and the real GDP decrease, a decrease in the money supply would not necessarily affect the price level, especially if other economic factors remain constant and velocity changes are unpredictable.
Step-by-step explanation:
The equation of exchange is a fundamental concept in economics that illustrates the relationship between the money supply, the velocity of money, the price level, and the quantity of goods and services produced in an economy, which is the real GDP. This equation is expressed as Money Supply X Velocity = Nominal GDP = Price Level X Real GDP. It is also known as the basic quantity equation of money.
According to this equation, if both the velocity of money and the quantity of goods and services decrease, a decrease in the money supply would theoretically not affect the price level, assuming all other factors remain constant. This is because a decrease in velocity and a decrease in real GDP suggest less economic activity and potentially less demand pressure on prices. However, in reality, various economic factors can interact in complex ways, leading to different outcomes.
If the velocity of money changes unpredictably, the effects of changes in the money supply on nominal GDP and the price level can become unpredictable. Thus, alterations in the money supply would have an unknown impact on the economy if velocity does not remain constant or changes in an unforeseeable manner.