FIGURE 27-5
-Refer to Figure 27-5.This economy begins in equilibrium with , and real GDP equal to potential GDP (with and ).Now suppose there is an increase in the money supply to $540 billion.In the long run,after all adjustments have taken place,what is the effect of the increase in the money supply?

Question

FIGURE 27-5
-Refer to Figure 27-5.This economy begins in equilibrium with  ,  and real GDP equal to potential GDP (with  and  ).Now suppose there is an increase in the money supply to $540 billion.In the long run,after all adjustments have taken place,what is the effect of the increase in the money supply?

Quizplus · Accepted Answer

The increase in the money supply causes an increase in aggregate demand. Initially, the economy moves along the short-run aggregate supply curve upwards and the price level increases. However, as firms raise prices and output, wages and other input prices also adjust upwards. This causes a leftward shift in the short-run aggregate supply curve until it intersects the long-run aggregate supply curve at potential GDP.

In the long run, the increase in the money supply only affects nominal variables, such as the price level, while real variables remain unaffected. Therefore, the long-run equilibrium occurs at the intersection of the long-run aggregate supply curve and the aggregate demand curve with a higher price level but no change in real GDP or the interest rate.

Option A is incorrect because it underestimates the influence of the increased aggregate demand on the price level. Option C and D are incorrect because they erroneously assume that the increase in the money supply will cause a persistent decrease in the interest rate and an increase in potential GDP respectively, neither of which happens in the long-run. Option E is incorrect because it includes an increase in real GDP, which is not supported by the information provided.

FIGURE 27-5 -Refer to Figure 27-5.This Economy Begins in Equilibrium with