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      Question

      Friedman’s money demand function Md/P = f(Yp, rb, re,

      π, w). A key implication that supports the Quantity Theory is:
      A Money demand is highly sensitive to interest rates, making monetary policy powerful and velocity unpredictable Correct Answer Incorrect Answer
      B Money demand is stable because permanent income is smooth, and velocity is predictable, restoring the classical link between money and nominal income Correct Answer Incorrect Answer
      C Inflation (Ï€) reduces money demand, causing hyperinflation to be self-correcting through reduced real money balances Correct Answer Incorrect Answer
      D The inclusion of human wealth (w) makes Friedman’s demand function empirically unverifiable Correct Answer Incorrect Answer

      Solution

      Friedman’s key insight: money demand depends on permanent income (Yp, which is smooth and stable) rather than current income (volatile). With a stable demand function, velocity V = PY/M is predictable — restoring the Quantity Theory: ΔM translates predictably into ΔP or ΔY. Keynes argued money demand is volatile (speculative motive → unstable velocity → monetary policy unreliable). Option (A) is the Keynesian position. Friedman directly refuted it.

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