Question

There are fundamentally two possible changes in an economy that will each cause inflation unless other compensating changes also occur. These changes are either reductions in the supply of goods and services or increases in demand. In a pre-banking economy the quantity of money available, and hence the level of demand, is equivalent to the quantity of gold available.

If the statements above are true, then it is also true that in a pre-banking economy

(A) any inflation is the result of reductions in the supply of goods and services

(B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation

(C) if there is a reduction in the quantity of gold available, then, other things being equal, inflation must result

(D) the quantity of goods and services purchasable by a given amount of gold is constant

(E) whatever changes in demand occur, there will be compensating changes in the supply of goods and services

Answer 1

If the statements above are true, then it is also true that in a pre-banking economy:

• B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation.

In a pre-banking economy, the quantity of gold equals the demand for gold. So if the quantity supplied of gold increases, we will increase the demand for gold. When the demand for money increases, both interest rates (not applicable here) and inflation rate increases.