Which theory relates money supply and the velocity of money to overall price levels?

The Quantity Theory of Money is fundamentally linked to the relationship between money supply, the velocity of money, and overall price levels in an economy. According to this theory, the equations can be expressed as MV = PQ, where M represents the money supply, V represents the velocity of money (the rate at which money is exchanged), P is the price level, and Q is the quantity of goods and services produced in the economy.

This theory posits that an increase in the money supply will lead to a proportional increase in the price level if the velocity of money and the quantity of goods and services remain constant. Essentially, if there is more money in circulation and the same amount of goods and services, prices must rise. This foundational concept is significant in understanding inflation and the effects of monetary policy on the economy, making the Quantity Theory of Money a key principle in monetarist economic theory.

The other theories provided do not directly connect the dynamics of money supply and velocity with price levels in the same systematic way as the Quantity Theory of Money does, which is why they are not the correct answer in this context.