Question

According to the classical dichotomy, what increases when the money supply increases?

a. the value of money
b. the real interest rate
c. the real gdp
d. the price level

Answer 1

The classical dichotomy separates real and nominal variables, so when the money supply increases, this leads to an increase in the price level rather than affecting real economic variables such as the real GDP or the real interest rate.

Step-by-step explanation:

According to the classical dichotomy, the classical dichotomy is the theoretical separation of real and nominal variables in an economy, suggesting that nominal variables do not affect real economic outcomes. Therefore, when the money supply increases, nominal variables like the price level are expected to increase, not real variables like the value of money, real interest rate, or real GDP. This is because in the long run, prices adjust proportionately to changes in the money supply.