Question

What would happen to output and the price level in the long run if the Fed increased the money supply?

What would happen to output and the price level in the short run if government expenditure permanently declined?

Use our AS-AD framework for this question.

Answer 1

The increase in the money supply will lead to an increase in consumer spending. This increase will shift the AD curve to the right. Increased money supply causes reduction in interest rates and further spending and therefore an increase in AD.

Thus:
A money supply increase will lead to increases in aggregate demand for goods and services. A money supply increase will tend to raise the price level in the long run. A money supply increase may also increase national output.