1 Suppose the economy is overheating and inflation is very high. The Central Bank tries to reduce prices by reducing the supply of money in the economy.

a. Explain all the steps through which a decrease in money supply leads to lower prices. Use the equilibrium in the Money market, the IS-LM model, and the AS-AD model to support your answer.

b Does the mechanism in a. imply a shift of the AD curve or a movement along the AD curve?

c Explain using the concept of the Short Run Aggregate Supply Curve why the decrease in would prices lead firms to produce less?

d. Does the mechanism in c. imply a shift of the AS curve or a movement along the AS curve?

e What would happen to prices in the long run, once people in the economy have adjusted their price expectations? What would be the mechanism?

f Does the mechanism in e. imply a shift of the AS curve or a movement along the AS curve?