Consider an initial IS-LM equilibrium point which corresponds to a point labeled "A" on the current AD curve.
-Refer to the information above.If the nominal money supply falls by 4 percent,accompanied by a 4 percent fall in the price level,the resulting IS-LM equilibrium corresponds to a point in the AD diagram
A)which is exactly point A again.
B)4 percent straight above A on a new AD curve.
C)4 percent straight below A on a new AD curve.
D)directly to the right of A on a new AD curve.
E)directly to the left of A on a new AD curve.

Question

Quizplus · Accepted Answer

A decrease in nominal money supply results in a leftward shift of the LM curve. This leads to a higher interest rate and lower output level. The decrease in the price level (i.e. deflation) only leads to a movement along the LM curve towards the lower right. As a result, both the IS and LM curves shift to the left, leading to a new equilibrium at a lower output level and higher interest rate. This new equilibrium point corresponds to a point on the AD curve that is 4 percent straight below point A on the original AD curve. Therefore, the correct choice is C.

Consider an Initial IS-LM Equilibrium Point Which Corresponds to a Point