Which of the following best explains why a sustained increase in the money supply without a corresponding rise in output leads to inflation according to the quantity theory of money?

💡 Solution & Explanation

According to the quantity theory of money, expressed through Irving Fisher's equation of exchange, holding velocity and transaction volume relatively stable, an increase in the money supply directly translates to a proportional rise in the price level. When more currency chases a fixed amount of goods and services, the intrinsic purchasing power of each unit of currency diminishes. Sellers respond to excess aggregate demand by raising nominal prices. Monetarist economic theory strongly emphasizes this direct causal linkage between excessive monetary expansion and inflationary pressures.