If the money supply decreases by 5%, in the long run:
A) interest rates rise by 5%.
B) the unemployment rate rises by 10%.
C) the price level drops by 5%.
D) real GDP drops by 5%.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, a decrease in the money supply will lead to a decrease in aggregate demand, which in turn puts downward pressure on prices. Therefore, the price level drops by 5%. Neither interest rates nor the unemployment rate are directly affected by changes in the money supply in the long run. Real GDP may be impacted but the question does not provide enough information to determine the extent of that impact.

If the Money Supply Decreases by 5%, in the Long