Consider the following statements about the transaction demand for money, MdT = k.P.Y:
(A) Y is the real GDP and P is the general price level or the GDP deflator.
(B) If the price level rises and real GDP stays the same, the transaction demand for money rises.
(C) k is the inverse of the velocity of circulation of money.
(D) If real GDP doubles and the price level falls to half, the transaction demand for money doubles.
(E) If both P and Y double, the transaction demand for money also doubles.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → (A), (B) and (C) only
MdT = k.P.Y depends on the product P × Y. Any change that leaves P × Y the same leaves money demand the same.
(A) Y is the real GDP and P is the general price level or the GDP deflator. — Correct. These are the meanings of Y and P in the equation.
(B) If the price level rises and real GDP stays the same, the transaction demand for money rises. — Correct. Demand is positively related to the price level.
(C) k is the inverse of the velocity of circulation of money. — Correct. v = 1/k, so k = 1/v.
(D) If real GDP doubles and the price level falls to half, the transaction demand for money doubles. — Incorrect. (P/2) × 2Y = P × Y, so demand stays unchanged.
(E) If both P and Y double, the transaction demand for money also doubles. — Incorrect. 2P × 2Y = 4PY, so demand becomes four times.
NCERT (2026-27): “… where, v = 1/k is the velocity of circulation. …” “… where Y is the real GDP and P is the general price level or the GDP deflator. The above equation tells us that transaction demand for money is positively related to the real income of an economy and also to its average price level.” |