If the money supply increases by 10 percent and nominal GDP also increases by 10 percent in the same period, what happens to velocity?

• A. Velocity remains unchanged.
• B. Velocity increases.
• C. Velocity decreases.
• D. Velocity becomes negative.

Answer: (A)

The key idea is the quantity equation MV = PY, where velocity is V, money supply is M, and nominal GDP is PY. Velocity measures how many times a dollar circulates in a period. If the money supply rises by 10% and nominal GDP also rises by 10%, the ratio V = PY/M stays the same because both the numerator and the denominator grow by the same amount. In other words, a 10% increase in PY with a 10% increase in M leaves V unchanged. If one grew faster than the other, velocity would move in the direction of that difference, but with equal 10% changes, velocity remains unchanged.