Question 80

Nominal income in Year 2 is $20 trillion.

According to the quantity theory of money, if the money supply doubles, nominal income will also double, assuming velocity remains constant. Given that the nominal income in Year 1 is $10 trillion, it follows that nominal income in Year 2 would be $20 trillion when the money supply increases.

A) $2 trillion

This option is incorrect as it significantly underestimates the impact of the doubling of the money supply. The quantity theory of money suggests that nominal income should at least maintain or increase proportionately with changes in the money supply, not decrease to such a low figure.

B) $14 trillion

While this option reflects some increase, it fails to account for the full doubling of the money supply from $10 trillion in nominal income. According to the quantity theory, nominal income should match the increase in money supply, which would be $20 trillion instead.

C) $20 trillion

This option is correct. When the money supply doubles from $2 trillion to $4 trillion, nominal income should also double from $10 trillion to $20 trillion, assuming the velocity of money remains constant. This aligns perfectly with the principles of the quantity theory of money.

D) $40 trillion

This option incorrectly suggests that nominal income would quadruple in response to the doubling of the money supply. The quantity theory indicates a direct proportionality, meaning nominal income would only double, not increase to such an extreme level.

Conclusion

The correct answer, $20 trillion, directly follows from the quantity theory of money, which states that an increase in the money supply leads to a proportional increase in nominal income, assuming constant velocity. All other options either underestimate or misinterpret the relationship dictated by this economic theory, making them incorrect.