Assume that the economy begins in long-run equilibrium.Then the Bank of Canada reduces the money supply.In the short run ______,whereas in the long run prices ______ and output returns to its original level.
A) output decreases and prices are unchanged; rise
B) output decreases and prices are unchanged; fall
C) output and prices both decrease; rise
D) output and prices both decrease; fall

Question

Quizplus · Accepted Answer

In the short run, the reduction in money supply leads to a decrease in aggregate demand, which leads to a decrease in output and employment. However, prices remain unchanged because firms are reluctant to lower prices in the short run. In the long run, prices will eventually adjust downward to restore long-run equilibrium, and output will return to its original level. Therefore, in the long run, output decreases initially but returns to its original level, and prices fall.

Assume That the Economy Begins in Long-Run Equilibrium