An increase in the money supply:

Question

Quizplus · Accepted Answer

An increase in the money supply is likely to lead to inflation when the economy is at or close to full employment. This is because, at full employment, an increase in demand resulting from more money being in circulation leads to businesses increasing their prices as they struggle to meet the higher demand. However, if there is a high rate of unemployment in the economy, an increase in the money supply is not likely to cause inflation, as there is unused productive capacity that can meet the increased demand. Choice A is incorrect because, as explained, an increase in the money supply is not always accompanied by inflation. Choice B is incorrect because an increase in the money supply shifts the aggregate demand curve to the right, not the left. Choice D is incorrect because an increase in the money supply usually leads to lower interest rates, not higher interest rates.

An Increase in the Money Supply