Question

Describe and explain the short-run and long-run effects of an exogenous decrease in money demand on a closed economy.

1. What is the effect of an exogenous decrease in money demand in the Aggregate Demand/Aggregate Supply (AD/AS) diagram?

2. Consumption

3. Real GDP

4. Price level

5. Unemployment

6. Interest rate

7. Investment

Answer 1

The decrease in exogenous
demand for money will lead to
the decreased AD in the
economy. Hence as a result the
AD will shift leftward.
As a result of the fall in demand
for money, there will be lesser
money with people, hence
their consumption will drop.
The leftward shift of AD will
lead to the fall in the price level
and real GDP causing the
creation of recessinary gap in
the economy.
At this level, the level of
unemployment rises as the
economy is performing under
the potential level of output.
The intetest rates fall in the
economy due to the decreased
demand for money. Investment
also fall because people are not
demanding money, hence
investments decrease.

In the long run , due to lesser interest rates , the demand again starts rising , leading the roghtward shift of AD curve and closing of recessionary gap.