Question

suppose the Fed reduces the money supply in an economy initially in long run equilibrium.

a. what will happen to output and prices in short run

b. what will happen to unemployment in short run

c. what will happen to output and prices in long run

Answer 1

a) Starting from the long run equilibrium, a decrease in the money supply it will shift the demand curve to the left and that will reduce the price level in the short run.

b) As the demand drops that will reduce the economic activity and unemployment will increase in the short run.

c) In the long run, with increased unemployment the wages will fall, and that will shift the supply curve to the right that will reduce the price even further and decrease the unemployment in the market.