According to the quantity theory of money: a

Answer

3. According to the quantity theory of money:

a. Flexible

According to the quantity theory of money, the prices are flexible.

_____________________________________________________

b. If the money supply is increased by 5%, then real GDP will increase by 0% and the price level will increase by 5%.

_____________________________________________________

The quantity theory of money is as follows,

MV = PY,

Where,

M = Money supply,

V = Velocity of money

P = General price level of the economy,

Y = Real GDP

According to the quantity theory of money, the money supply and price level change in direct proportion. From this, we conclude that, the prices are flexible. Again, according to the theory, when the money supply changes, the nominal GDP (PY) changes at the same proportion as the change of money supply, and the real GDP(Y) remains the same. So, here, we can say that, if the money supply is increased by 5%, then real GDP will remain same, i.e., it will increase by 0% and, the price level will increase by 5%.