FIGURE 27-5 Refer to Figure 27-5.This economy begins in equilibrium with M_S⁰,M_D⁰ and real GDP equal to potential GDP (with and ).Now suppose there is an increase in the money supply to $540 billion.In the long run,after all adjustments have taken place,the money supply is ________,the interest rate is ________,the price level is ________,and real GDP is ________.

Question

Quizplus · Accepted Answer

An increase in the money supply shifts the money supply curve to the right, from MS1 to MS2. This creates an excess supply of money at the initial interest rate, so individuals and businesses increase spending, causing an increase in aggregate demand and an increase in the price level. As prices rise, the real money supply falls, causing interest rates to rise.

In the long run, the increase in the money supply is fully reflected in the price level, but not in real GDP or the interest rate. Real GDP returns to potential GDP and the interest rate returns to its initial level.

The new equilibrium is at point E, where MS2 intersects with the LRPC and SRPC1. At this point, the quantity of money is $540 billion, the interest rate is 4%, the price level is 104, and real GDP is $800 billion. Therefore, the correct answer is (E).