Which statement best describes the velocity of money and its relationship to nominal GDP?

• A. It measures how frequently a unit of money circulates in a period, with V = PY/M.
• B. It measures the total money supply.
• C. It measures the rate of inflation.
• D. It measures the stock of capital used in production.

Answer: (A)

The main idea being tested is how the velocity of money relates to nominal GDP through the quantity equation. In the quantity equation, money supply times velocity equals nominal GDP: M × V = P × Y, where P is the price level and Y is real output. Since nominal GDP is P × Y, you can rearrange the equation to V = (P × Y) / M. This shows that velocity is the rate at which a unit of money circulates in the economy: how often money changes hands to support a given level of nominal spending.

So the statement is correct because it directly defines velocity as the turnover rate of money and shows its relationship to nominal GDP through V = PY/M. If money money supply grows but spending remains the same, velocity would drop to keep PY consistent with M; if spending grows faster than the money supply, velocity would rise, and so on. This concept doesn’t describe the total money supply itself, nor the inflation rate directly, nor the stock of capital used in production.