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,what is the effect of the increase in the money supply?

Question

Quizplus · Accepted Answer

An increase in the money supply will shift the MS1 curve to the right, and the new long-run equilibrium will occur at the intersection of MS2 and AS. This will result in an increase in the price level from P1 to P2, but no change in real GDP or the interest rate.

Choice A is incorrect because the increase in money supply will lead to a larger shift in the MS curve, resulting in a larger increase in the price level.

Choice C is incorrect because the decrease in the interest rate is a short-run effect of the increase in the money supply, but in the long run, the interest rate will return to its original level.

Choices D and E are incorrect because an increase in potential GDP or real GDP require long-term changes in the economy, and a single increase in the money supply will not lead to a permanent increase in these variables.