Think about circular flow chart. Suppose an economy with one firm and one househ

Question

Think about circular flow chart. Suppose an economy with one firm and one household where the firm pays householder $4000 every month for the labor provided by householder to produce goods. After work, the householder spends $4000 on the goods the firm produced. Then next period the firm can pay $4000 to the householder again, and the cycle continues. Now suppose central bank injects more liquidity ($1000) into the economy. By Theory of Money, MV=PY, what changed? P decreased M increased P increased Y decreased V increased V decreased M decreased Y increased

Explanation / Answer

According to the theory of Money or equation of exchange, when the Central Bank injects more liquidity in the economy. then in the equation, M will be increase due to increase in the money supply in the economy. Since there is one to one relation between m and p as v and y are assumed to be constant. so the price will rise by an equal amount.

Thus, answer is M increased. If there is an option to select more than one choices then also mark- P increased.

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