Consider the AS-AD model of the economy where output is currently at its natural level.

a) What does this imply about the relationship between the price level, P, and

the expected price level, P^e? Explain.

Suppose now that the central bank decides to decrease the nominal money supply from M

to M

b) Explain graphically both, the short run and the medium run effects of the

decrease in the nominal money supply on the output Y and the price level P, using the

AS-AD model.

c) Explain graphically both, the short run and the medium run effects of the

decrease in the nominal money supply on the interest rate i, by linking the AS-AD model

to the IS-LM model.