Exhibit 20-6 Money, investment and product markets In Exhibit 20-6, if the Fed believes the economy is at AD₃, how might it engineer a decline in the price level?

Question

Quizplus · Accepted Answer

According to the exhibit, at AD₃, the economy is suffering from inflation, meaning the price level is too high. To engineer a decline in the price level, the Fed would need to decrease the money supply. This would lead to a rise in the interest rate, which would discourage investment, leading to a fall in aggregate demand and ultimately a fall in the price level. Option C describes this process accurately.

Exhibit 20-6 Money, Investment and Product Markets in Exhibit 20-6