Starting from a position of macroeconomic equilibrium at below the full-employment level of real GDP, an increase in the money supply will:
A) raise interest rates, prices, and reduce real GDP.
B) raise interest rates, lower prices, and leave real GDP unchanged.
C) Raise interest rates, lower prices, and leave real GDP unchanged.
D) lower interest rates, raise prices, and increase real GDP.

Question

Quizplus · Accepted Answer

An increase in the money supply will lower interest rates as it leads to an increase in the supply of loanable funds. This, in turn, will boost investment and consumer spending, leading to an increase in demand and output. Since the economy is initially operating below full employment, there is scope for higher output without running into inflationary pressures. The increase in aggregate demand will, therefore, lead to an increase in output (real GDP) with only a relatively small increase in the price level.

Starting from a Position of Macroeconomic Equilibrium at Below the Full-Employment