Given the expected price level, policies for reaching potential GDP will work best if the money supply is _____
A) large, so that prices at potential GDP are below expectations and people can afford to buy enough goods to support the natural level of employment.
B) large enough that prices at potential GDP exceed expectations and firms can afford to hire workers.
C) small, so that prices at potential GDP fall below expectations and people can afford to buy enough goods to support the natural level of employment.
D) small, so that prices at potential GDP exceed expectations and firms can afford to hire workers.
E) exactly the size that makes prices equal to the prices people expected to prevail.

Question

Quizplus · Accepted Answer

The best policy for reaching potential GDP is to have the money supply exactly the size that makes prices equal to the prices people expected to prevail. This is because when prices are at the expected level, both firms and individuals will be able to make optimal economic decisions, leading to a more efficient allocation of resources and ultimately higher output at potential GDP. If the money supply is too large, prices will be higher than expected, causing firms to overproduce and individuals to demand less, leading to an inefficient allocation of resources. If the money supply is too small, prices will be lower than expected, causing firms to underproduce and individuals to demand more, leading to output below potential GDP.

Given the Expected Price Level, Policies for Reaching Potential GDP