Which of the following unambiguously leads to inflation?

• A. A decrease in the money supply
• B. A decrease in aggregate demand
• C. An increase in the money supply without a corresponding increase in output
• D. An increase in productivity

Answer: (C)

Verified step by step guidance

1. Understand the concept of inflation: Inflation is the general increase in the price level of goods and services in an economy over a period of time.
2. Recall the Quantity Theory of Money, which relates money supply (M), velocity of money (V), price level (P), and output (Y) through the equation: \(M \times V = P \times Y\).
3. Analyze each option in terms of its effect on the price level (P):
4. - A decrease in the money supply (M) tends to reduce the price level, leading to deflation rather than inflation.
5. - A decrease in aggregate demand reduces overall spending, which typically lowers the price level, not increases it.
6. - An increase in the money supply (M) without a corresponding increase in output (Y) means more money chasing the same amount of goods, which tends to increase the price level, causing inflation.
7. - An increase in productivity increases output (Y), which can lower prices or keep them stable, counteracting inflationary pressures.