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Question: According to Monetarism, when does an increase in money supply change only price level and...

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According to Monetarism, when does an increase in money supply change only price level and
not Real GDP? In the short run or in the long run? Explain your answer using a diagram.

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Answer #1

Suppose the economy is in long run equilibrium which is attained at SRAS = AD = LRAS. Now, suppose there is increase in money supply by the central bank as a result AD curve will shift to the right. As a result in the short run there will be an inflatiionary gap as output will rise. But in the long run wagers will revise their expectations upward which raises the SRAS upward and this will continue until the new equilibrium is not reached and at that equilibrium output remains at full employment and only price level will change.

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