If the money stock doubles from one period to the next and real GDP remains constant, what happens to the price level?

• A. The price level falls by half.
• B. The price level doubles.
• C. The price level remains unchanged.
• D. Prices rise, but not by a predictable amount.

Answer: (B)

The money stock and the price level move together through the equation MV = PY, where V is how often money circulates, P is the price level, and Y is real GDP. If the money stock doubles and real GDP remains the same, and we assume velocity is unchanged, then the left side (MV) doubles. To keep the equality, the right side (PY) must also double. Since Y is constant, P must double as well. So the price level rises to twice its original level. If velocity weren’t constant, the exact amount of price change could differ, but with a stable V the outcome is a doubling of the price level.