There are fundamentally two possible changes in an economy that will

Question

There are fundamentally two possible changes in an economy that will each cause inflation unless other compensating changes also occur. These changes are either reductions in the supply of goods and services or increases in demand. In a pre-banking economy the quantity of money available, and hence the level of demand, is equivalent to the quantity of gold available.

If the statements above are true, then it is also true that in a pre-banking economy

(A) any inflation is the result of reductions in the supply of goods and services

(B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation
 
(C) if there is a reduction in the quantity of gold available, then, other things being equal, inflation must result

(D) the quantity of goods and services purchasable by a given amount of gold is constant

(E) whatever changes in demand occur, there will be compensating changes in the supply of goods and services

CR00661.01

mikemcgarry · Accepted Answer

Dear slatewalamurtuza I'm happy to respond. :-)

I must say that I am somewhat skeptical about this question because of the poor quality of writing in the stem. All CR questions on the GMAT adhere entirely to the very high standard of grammar & rhetoric held on the GMAT SC. This question falls short, often indicating a low question quality. Nevertheless, there is only one clearly right answer. You may find this blog provides some helpful background for this question: https://magoosh.com/gmat/2012/inflation- ... -the-gmat/ First of all, it's very important to note from the passage Fact #1 : inflation is caused by (1) reduction in supply of goods & services, or (2) increase in demand Fact #2 : in prebanking economy, amount of gold = amount of demand Those two are very big. Now, the answers: (A) any inflation is the result of reductions in the supply of goods and services this would be true if the demand (i.e. the supply of gold) remained constant --- but we can't assume that, so we can infer this answer. This is incorrect. (B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation Gold = demand. If we increase gold, we increase demand, which is one cause of inflation. This is a very promising answer. (C) if there is a reduction in the quantity of gold available, then, other things being equal, inflation must result Reduce gold ==> reduce demand. That does not lead to inflation --- it leads in the opposite direction (toward recession). This is incorrect. (D) the quantity of goods and services purchasable by a given amount of gold is constant This would not be true if inflation happened. Inflation means the same money buys fewer goods. This is incorrect. (E) whatever changes in demand occur, there will be compensating changes in the supply of goods and services No! If that happened, there never would be inflation or recession! The economy would be magically balanced at every moment. That is pure fairyland fantasy. Supply and demand are independent and uncorrelated: hence, the realities of inflation and recession. This answer is incorrect. The only tenable answer is (B) . It's true that it's helpful to understand the basics of how inflation operates to interpret this question. But, if you plan to go to business school and get an MBA, you had better understand in detail how inflation works! Does all this make sense? Mike :-)

GMATIntensive · Answer

The Story     
 There are fundamentally two possible changes in an economy that will each cause inflation unless other compensating changes also occur.   - Inflation is caused by one of the two changes in an economy unless other changes occur that compensate for the impact of the initial change.

These changes are either reductions in the supply of goods and services or increases in demand.  - What are the two possible changes? (1) reductions in supply, and (2) increases in demand. (So, if the supply reduces OR the demand increases, inflation will occur. Unless other changes compensate for the supply/ demand change)

In a pre-banking economy the quantity of money available, and hence the level of demand, is equivalent to the quantity of gold available.  - In a pre-banking economy, the quantity of gold available = the quantity of money available = the level of demand. I.e, the level of demand corresponds to the quantity of gold available. (More the gold available, higher the demand. Less the gold available, lower the demand.)

Gist:  Two factors cause inflation: (1) reduction in supply, and (2) increase in demand. Before banking became prevalent, the level of demand was determined by the quantity of gold available.

(Since the given passage is not an argument, we are not going to try to find any gaps here.)

The Goal     
What can we infer about a pre-banking economy? An economy in which demand is governed by the quantity of gold. And we know that ‘reduction in supply’ or ‘increase in demand’ causes inflation. One thing that comes to mind is: if the quantity of available gold increases, and all else remains the same, there will be inflation (since demand will increase).

The Evaluation     
 (A) any inflation is the result of reductions in the supply of goods and services 
  Incorrect  . Inflation can be caused by either an increase in demand or a reduction in supply. We cannot infer that ‘any inflation’ is the result of reductions in the supply. There might very well also be inflations that are the result of an increase in demand. There is nothing mentioned in the passage for us to infer that demand does not fluctuate in the pre-banking economy.

(B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation 
  Correct  . This is completely in line with our prediction above. Increasing the quantity of gold available will increase demand, and if other factors are unchanged, that increase in demand will lead to inflation.

(C) if there is a reduction in the quantity of gold available, then, other things being equal, inflation must result 
  Incorrect  . This option might seem attractive in the first look. However, on reading it precisely, one can understand that the option actually is in the opposite direction. Reduction in the quantity of gold available would reduce demand. What does a reduction in demand lead to? Nothing is given in the passage. Common sensically, if an increase in demand leads to inflation, a decrease in demand should not lead to inflation.

Ok, let’s try a modification. Can we infer the following: 
  if there is a reduction in the quantity of gold available, then, other things being equal,  inflation  deflation must result

Let us know what you think in the comments below.

(D) the quantity of goods and services purchasable by a given amount of gold is constant 
  Incorrect  . ‘Inflation’ is a general increase in prices. The quantity purchasable by a given amount of gold would remain constant only if there were no inflation (or deflation). That would happen only if the factors that impact the economy do not change. There is nothing in the passage that even suggests that these factors do not change.

(E) whatever changes in demand occur, there will be compensating changes in the supply of goods and services 
  Incorrect  . There is no correlation given between ‘demand’ and ‘supply’. Changes in demand could very well occur without compensating changes in supply.

Additional Notes     
nflation and role of demand and supply are quite often used as subject matter in CR questions. While the questions do not need any pre-existing knowledge of economics to answer, some familiarity does make it easier to understand the passage. At the same time, as always, it is imperative that we do not add our own pre-existing knowledge to what has been stated. Here’s a post that elaborates a bit on demand and supply.

SC Notes: 
Use of ‘being’ in option C. Being is a part of the English language, and can very well be used in a grammatically correct sentence.

If you have any doubts regarding any part of this solution, please feel free to ask.

Hkreation · Answer

Guys, you have explained best... but still 1 doubt stands for me.....

Current demand is equal to available Gold.....

Now if gold quantity reduces, and "other things being equal" means same.... then relative demand should increase..... which states C CORRECTLY.

let's say... there are 100 mangoes.... and 100 people... all will have 1 mango...

if we reduce it's quantity by 20... and available is now 80 only.... then demand will increase... right??? as 100 are there for only 80...

Let me know where am I missing something?

mikemcgarry · Answer

Dear Hkreation , I'm happy to respond. :-)

My friend, I think you are confusing currency and goods. Suppose we have some group of people with $100, and there are 100 mangoes. Supply has to do with the number of mangoes, with the goods available. Demand has to do with the amount of money, with the purchasing power available. If we increase or decrease the number of mangoes, we increase or decrease supply. If we increase or decrease the amount of money, we increase or decrease demand. Increasing the monetary supply increases the demand, which causes inflation. In this situation, you are confusing gold with a consumer good. It's not. It's a form of currency. The fact that we are using the word " demand " to discuss necessarily implies that it is a currency, not a consumer good. If it were a consumer good, the word we would use is " supply ." In addition to this, the passage makes very clear that "gold" underlies the currency system. It is extremely important to be clear on the difference between " supply " and " demand ." See: https://magoosh.com/gmat/2012/gmat-supply-and-demand/ Does all this make sense? Mike :-)

DmitryFarberMPrep · Answer

B and C both address the idea that demand is equivalent to the quantity of available gold. If all else remains equal, an increase in available gold will increase demand and thereby cause inflation. B says exactly this: that an increase in gold will cause inflation. C says that a  decrease  in gold will cause inflation. As Mahendru said, this is the opposite of B, and it is directly contradicted by the passage.

sairam595 · Answer

Please explain why option c is incorrect.

Option C supports premise "There changes are either reductions in the supply of goods and services or increases in demand"

DmitryFarberMPrep · Answer

Well, first off, we aren't trying to support the premises. That is  never  the task in CR. In this case, we've been asked to infer something, so we grant all the statements in the argument as true and try to see what else we know from there.

We know that demand varies directly with the quantity of available gold. Since increased demand leads to inflation, an increase in the availability of gold will cause inflation (by bringing about an increase in demand). That directly supports B.

C talks about what will happen if the availability of gold, and therefore demand, goes down. While we aren't actually told what happens when demand goes down, we have no reason to believe that inflation will occur. Inflation happens when demand goes  up .

AryamaDuttaSaikia · Answer

It has been stated in the premise that the quantity of money available is equivalent to the quantity of Gold available. Hence, an increase in gold quantity will lead to inflation not reduction. "C" mentions a reduction in Gold quantity will lead to inflation which is not true.

gmatt1476 · Answer

Official Explanation

Argument Construction

This question asks us which of the statements is most strongly supported by the information in the argument. Given no other relevant changes, two factors can cause inflation: a reduction in market supply of goods and services or an increase in market demand. The argument also indicates that the total quantity of money available—or, in a pre-banking economy, the quantity of gold available—determines market demand. Therefore, in a pre-banking economy, an increase in the quantity of gold available will increase demand. In a situation where supply remains constant, this increases demand for this fixed supply, thereby raising prices. In other words, increasing the quantity of gold in a pre-banking economy will cause inflation.

A. While this may be true in certain cases, it is not the argument made in the passage. The passage indicates that certain instances of inflation are caused by increased demand stimulated by an increase in available money (or gold).

B. Correct. According to the information in the passage, if the quantity of available gold in a pre-banking economy increases while supply of goods and services remains unchanged, demand for goods and services will increase relative to supply. This imbalance raises prices for the supply; that is, it causes inflation.

C. This answer suggests the opposite of the information in the passage. While the information in the passage indicates that an increase in the quantity of available gold may cause inflation, this choice suggests that a reduction in the available amount of gold will cause inflation.

D. This suggestion is contrary to the information in the passage: the passage suggests that in a pre-banking economy, the total available amount of gold determines the amount that a good or service will cost. This answer choice suggests that the total available amount of gold is irrelevant to the cost of given goods or services.

E. The passage nowhere indicates that economies will compensate for changes in demand by changing available supply. This suggestion may or may not be true in real-world terms, but there is no information in the passage to support it.

The correct answer is B.

sajalgargciv2805 · Answer

(A) any inflation is the result of reductions in the supply of goods and services  
Not necessarily true. There are two factors given for the cause of inflation and "reductions in the supply of goods and services" is only one of them.

(B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation  
Now, this option seems good. The stimulus clearly mentions that only two factors can cause inflation, given other factors remain unchanged. This choice does just that.

(C) if there is a reduction in the quantity of gold available, then, other things being equal, inflation must result 
This is actually the opposite of what the stimulus says.

(D) the quantity of goods and services purchasable by a given amount of gold is constant  
Not necessarily true. The other factor, i.e., the change in the supply of goods and services can affect the quantity of goods and services purchasable by a given amount of gold.

(E) whatever changes in demand occur, there will be compensating changes in the supply of goods and services 
Again, not necessarily true.

gvij2017 · Answer

After going through the complete thread of discussion, I want to conclude the argument here in my way.

Inflation occurs if either supply side goes down or demand goes up along with no change in all other conditions.

Money available= demand = qty. of gold....Means gold is at demand side. 
Therefore, we can infer that increasing gold will cause inflation if rest of the condition remain unchanged.

Hope it will help many!

AliciaSierra · Answer

Hello  GMATNinja ,  VeritasKarishma ,

Could anyone of you please help me to understand below CR. When I read this CR, I couldn't understand what author is trying to convey, and I was not able to Pre-think or find Gap in it. What is Pre-Bank economy?

Thanks,

KarishmaB · Answer

AliciaSierra

2 causes of inflation: 'Decreased supply' and 'Increased demand'

In a pre-banking economy, 
quantity of money available = the level of demand = the quantity of gold available

So in a pre-banking economy, demand = quantity of gold

It doesn't matter whether you understand what a pre-banking economy is or not. All the information needed for you to answer the question will be given to you in the question itself. If I say in the economy of Suderlands, demand = quantity of gold, will you wonder what economy of Suderlands is? No. You won't bother. It is the same case here. (As per context, I would assume pre-banking economy means an economy which does not have banks yet)

(A) any inflation is the result of reductions in the supply of goods and services

No. Inflation could be due to increased in demand too. We are not given that quantity of gold is fixed.

(B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation

Correct. Increasing gold will increase demand which will lead to inflation (assuming everything else is fixed).

(C) if there is a reduction in the quantity of gold available, then, other things being equal, inflation must result

We don't know the impact of reduction in god i.e. reduction in demand.

(D) the quantity of goods and services purchasable by a given amount of gold is constant

Not given.

(E) whatever changes in demand occur, there will be compensating changes in the supply of goods and services

Not given.

Answer (B)

Iwillget770 · Answer

I feel, the main reason people are choosing  OPTION C  is that they are confusing  reduction in quantity of gold = Reduction in supply of goods and services. 
In such a case both OPTION B and OPTION C can be inferred , which is not possible in GMAT.

But when we carefully look at the QUESTION STIMULUS 
 
ie quantity of gold is equivalent to level of demand. Hence , if we change the  QUANTITY OF GOLD  then ..... only   DEMAND  will change ( no impact on SUPPLY).
Consequently, we cannot infer  OPTION C .

Regards

AGK_21 · Answer

If the statements above are true, then it is also true that in a pre-banking economy -   Would think of this question as MUST BE TRUE question.

(A) any inflation is the result of reductions in the supply of goods and services -  this is too broad, additionally, this option does not explicitly state other factors would remain same. Without this, we can't say this HAS to be true

(B) if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation -  This option explicitly mentions "other factors remain unchanged", so it solves the problem with option A. Increasing gold quantity ~ increasing demad + everything else remain same = Inflation

(C) if there is a reduction in the quantity of gold available, then, other things being equal, inflation must result -  This is total opposite. Reduction in gold means decline in demad (would assume that people buy goods and services with gold in pre banking economy). And decline in demad will not cause inflation.

(D) the quantity of goods and services purchasable by a given amount of gold is constant -  Nothing in the Stimulus say this HAS to be true.

(E) whatever changes in demand occur, there will be compensating changes in the supply of goods and services -  Same as D, nothing in the passage says this is true. In fact, if this is true, inflation would never occur.

egmat · Answer

Let me walk you through the core logic here.

Step 1: Map the Key Relationships

The passage gives us two clear rules:
- Two things cause inflation:  supply reduction  OR  demand increase 
- In pre-banking economies: gold quantity = money = demand level (direct equivalence)

Step 2: Connect the Chain

Here's what you need to see: since gold directly equals demand in these economies, changing gold quantity directly changes demand levels. More gold → more demand → inflation trigger.

Step 3: Test the Logic

Let's think about choice (B): "if other factors in the economy are unchanged, increasing the quantity of gold available will lead to inflation"

Following our chain:
- More gold available
- Therefore, more demand (because gold = demand) 
- Demand increase is one of the two stated causes of inflation
- "Other factors unchanged" means no compensating changes occur
- Result: inflation must occur

That's exactly what the passage logic tells us!

Step 4: Spot the Trap

Notice how choice (C) tries to trick you by suggesting gold  reduction  causes inflation. But think it through - less gold means less demand, and the passage says  increases  in demand cause inflation, not decreases.

The answer is (B) because it correctly follows the logical chain while ensuring no compensation occurs.

You can check out the  step-by-step solution on Neuron by e-GMAT  to master the systematic framework for all Must Be True questions in Critical Reasoning. You can also explore other GMAT official questions with detailed solutions on Neuron for structured practice  here .

mkeshri185 · Answer

How will we identify which is demand and which is supply between gold and money? In the last sentence it is not clear. Please help me understand how you break down the sentence.

There are fundamentally two possible changes in an economy that will

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GMAT Critical Reasoning (CR) Questions

There are fundamentally two possible changes in an economy that will

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