Which theory emphasizes a positive relationship between the price level and the money supply and uses MxV=PxY?

Which theory emphasizes a positive relationship between the price level and the money supply and uses MxV=PxY?

• A. Quantity theory of money
• B. Classical growth theory
• C. Keynesian theory
• D. Liquidity preference theory

Answer: (A)

The question tests the quantity theory of money, which uses the equation M×V = P×Y to link the money stock to the price level and real output. The key idea is that velocity is relatively stable over time, so changes in the money supply translate into changes in the price level. If the money supply grows while real output remains steady, the price level must rise to keep M×V in line with P×Y. Thus, there is a positive relationship between the money supply and the price level, with the long-run view that money mainly affects inflation rather than real GDP. Other theories focus on different mechanisms: Keynesian theory emphasizes short-run demand-driven fluctuations and price/wage rigidity; liquidity preference theory centers on how money demand affects interest rates; classical growth theory concerns long-run real growth in output rather than the direct link between money and prices.

The question tests the quantity theory of money, which uses the equation M×V = P×Y to link the money stock to the price level and real output. The key idea is that velocity is relatively stable over time, so changes in the money supply translate into changes in the price level. If the money supply grows while real output remains steady, the price level must rise to keep M×V in line with P×Y. Thus, there is a positive relationship between the money supply and the price level, with the long-run view that money mainly affects inflation rather than real GDP.

Other theories focus on different mechanisms: Keynesian theory emphasizes short-run demand-driven fluctuations and price/wage rigidity; liquidity preference theory centers on how money demand affects interest rates; classical growth theory concerns long-run real growth in output rather than the direct link between money and prices.