Question

2. A. In the long run, a positive, permanent upward shift in the production function will cause:

a. a fall in output and a fall in the interest rate

b. a fall in output but a rise in the interest rate.

c. a rise in output but a fall in the interest rate.

d. a rise in output and a rise in the interest rate.

NOTE: I only hinted at the interest rate part of this question when we discussed the additional points on

monetary policy. See if you can satisfy yourself of the correct answer.

B. Thoroughly explain using graphs.

Answer 1

a) permanent upward shift in the production function will cause a fall in output but a rise in the intrerest rate

so, correct option is B

B) with given AD curve , an upward shift in AS curve will decrease output level from y₀ to y₁ and increase price level from p₀ to p_1. now price level increases it means real money supply decreases. as a resullt LM curve shift leftward. now with given IS curve, leftward shift in LM curve increases interest rate from i₀ to i₁.