Question

What happens if the Federal Reserve Bank decreases the money supply? Make sure to include the appropriate equation, the money graph and the Short-run/long-run goods graph and discuss how this impacts GDP, P, and Unemployment in the Short-run and the long run.

Answer 1

Decrease in money supply will shift supply curve to left. At initial equilibrium interest rate, is there will shortage of money that will lead to increase in interest rate.

Increase in interest rate will decrease Investment and lead to decline in aggregate demand and AD curve shift left. At new short run equilibrium, GDP is lower than potential gdp and price is lower .andlower gdplead to higher unemployment.

In long run Being in recessionary gap,and decreasing price ,lead to decrease in wages which Decrease cost of Production to firms and aggregate supply curve Increase and shift right. Increase in aggregate supply lead to increase in GDP and increase it to potential GDP . And increase in aggregate supply Decreases price and increase unemployment.