If the quantity of money increases 100%, other things remaining constant, value of money changes by
- Increases by 100 %
- Decreases by 100 %
- Decreases by 200%
- Does not change
Correct answer: b. Decreases by 100%
If the quantity of money increases by 100%, other things remaining constant, value of money decreases by 100%. Because the value of money is inversely proportional to the quantity of money in circulation, it decreases in purchasing power when the quantity of money increases.
To better understand this concept, let’s look at a hypothetical economy in which only 100 dollars are in circulation and 10 goods are available for purchase. As a result, each dollar represents one tenth of the total amount of goods available (1 dollar equals one tenth).
If the quantity of money increases by 100% (i.e., it becomes 200 dollars), but the number of goods available remains the same (10 goods), the new value of money will change. Each dollar will be worth 1/20th of the total goods available (1 dollar = 1/20 goods).
Comparing the initial and final situations:
100 dollars are equal to 10 goods, so 1 dollar is equal to 1/10 of a good.
200 dollars equals 10 goods, so 1 dollar equals 1/20.
The value of each dollar has decreased by half (100%), which means money’s value has decreased by 100%.
Why the other options are not correct
a. Increase by 100%
There is no correlation between an increase in the quantity of money and an increase in its value. In fact, it is the opposite, since the quantity of money in an economy decreases the value of each unit of money, resulting in a decrease in purchasing power. As the money supply grows faster than the actual output of goods and services, the value of money erodes, and prices rise. This is known as inflation.
As a result of too much money chasing too few goods, inflation occurs. When people have more money, they are willing to pay more for goods and services, which allows sellers to raise prices without losing customers. While this increase in prices is not indicative of an increase in the value of money, it indicates that each unit of money now buys fewer goods and services.
c. Decrease by 200%
Because it presents a concept that is not based on reality, this option is incorrect. Using “decreases by 200%” implies a negative value, which does not make sense in terms of the value of money. While money can decrease, it cannot decrease more than 100% in value. If the value of money decreased by 100%, it would imply that it became zero, which would be the worst-case scenario for an economy, leading to hyperinflation and a loss of confidence in the currency.
People would have to pay double or more for the same goods and services if the value of money decreased by 200%, which is not feasible in practice. As a result of the inflation rate, where the purchasing power of money gradually decreases over time, it can only be depreciated to a certain extent.
d. Does not change
The value of money always changes when the quantity of money increases, so this option is incorrect. According to the quantity theory of money, money’s value and quantity are well-established in economics. As a result of this theory, money’s value is inversely proportional to its quantity.
When the money supply increases, more money is available in the economy to purchase the same amount of goods and services. This increase in money supply leads to an excess of demand over supply, which results in a rise in prices. The rise in prices signifies a decrease in the value of money, as each unit of money now has less purchasing power.
If the quantity of money increases by 100%, other things remaining constant, the value of money decreases by 100%. This decrease occurs because the quantity and value of money have an inverse relationship. Each unit of money becomes less valuable as the quantity in circulation increases, so it becomes necessary to spend more money to buy the same amount of goods or services.
Analyzing monetary policies and economic changes requires understanding the relationship between quantity and value of money.