9 . Money Supply

Suppose an economy is in long-run equilibrium. The central bank reduces the money supply by 5 percent.

Use your diagram to show what happens to output and the price level as the economy moves from the initial to the new short-run equilibrium.

Aggregate Demand

Aggregate Supply

Price Level

Quantity of Output

LRAS

Aggregate Demand

Aggregate Supply

Now adjust the graph to show the new long-run equilibrium.

What causes the economy to move from its short-run equilibrium to its long-run equilibrium?

Nominal wages, prices, and perceptions adjust upward to this new price level.

The government increases taxes to curb aggregate demand.

The government increases spending to increase aggregate demand.

Nominal wages, prices, and perceptions adjust downward to this new price level.

Which of the following is true according to the sticky-wage theory of aggregate supply as a result of the decrease in the money supply?Check all that apply.

Nominal wages at the initial equilibrium are greater than nominal wages at the new short-run equilibrium.

Nominal wages at the initial equilibrium are greater than nominal wages at the new long-run equilibrium.

Real wages at the initial equilibrium are less than real wages at the new short-run equilibrium.

Real wages at the initial equilibrium are less than real wages at the new long-run equilibrium.

Judging by the impact of the money supply on nominal and real wages, this analysis consistent with the proposition that money has real effects in the short run but is neutral in the long run.