If the price level rises, demand of real money increases proporitnally?
TRUE or FALSE
True
When there is an increase in the price level, the demand for money increases. Conversely, when there is a decrease in the price level, the demand for money decreases.
The statement is FALSE. When the price level rises, the purchasing power of money decreases. As a result, people need more money to maintain the same level of real purchasing power. This implies that the demand for real money decreases, not increases, proportionally.
To understand this concept, you can refer to the quantity theory of money, which states that the quantity of money in an economy is directly proportional to the price level. This means that when the price level increases, the demand for money decreases.
You can also use the equation of exchange, which states that the money supply (M) multiplied by the velocity of money (V) equals the price level (P) multiplied by the real GDP (Y):
MV = PY
If we hold the velocity of money and real GDP constant, and then increase the price level (P), it implies that the quantity of money (M) must also increase to maintain the equation. This increase in the money supply indicates that the demand for real money decreases as the price level rises.
In summary, as the price level rises, the demand for real money decreases, rather than increasing proportionally.