If the government increased the money supply in response to a decrease in short-run aggregate supply,unemployment would return towards its natural rate,but prices would rise even more.

Question

Quizplus · Accepted Answer

When the government increases the money supply, it leads to an increase in aggregate demand which can help bring unemployment towards its natural rate. However, if short-run aggregate supply decreases, it means that the cost of production has increased which will lead to higher prices. So, if the money supply is increased in response to a decrease in short-run aggregate supply, prices will rise even more. This is known as demand-pull inflation. Therefore, option A is correct.

If the Government Increased the Money Supply in Response to a Decrease