In the long run, increases in the money supply have no effect on the level of output because prices and wages will
A) rise as GDP exceeds potential output, causing real interest rates to rise and output to fall to its original level.
B) fall as GDP exceeds potential output, causing real interest rates to rise and output to fall to its original level.
C) rise as GDP exceeds potential output, causing real interest rates to fall and output to fall to its original level.
D) fall as GDP exceeds potential output, causing real interest rates to fall and output to fall to its original level.

Question

Quizplus · Accepted Answer

Increases in the money supply will initially increase output as it facilitates increased spending on goods and services. However, as GDP exceeds potential output, prices and wages will begin to rise which increases the demand for loanable funds and therefore real interest rates. This rise in real interest rates causes a fall in aggregate demand, which in turn reduces output to its original level. Therefore, in the long run, increases in the money supply have no effect on the level of output. Choice A correctly describes this process.

In the Long Run, Increases in the Money Supply Have