Question

1)Suppose that there is a monetary contraction. What are the effects of this monetary contraction on...

1)Suppose that there is a monetary contraction. What are the effects of this monetary contraction on output and interest rate? (Hint: How does it shifts the IS and the LM curves?)

2)Derive the AS relation and draw the AS curve. Explain the properties of AS relation

3)Derive the AD relation using IS-LM graphs   

4)Please explain the effects of the monetary contraction in the short and medium run.   

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Answer #1

Ans 1.) When there is monetary contraction, the money supply in the economy decreases and the LM curve shifts towards the left as can be seen in the diagram below.

This leads to the increase in the interest rate and thus the investment spending decreases due to the high interest rates.This further leads to the decline in the overall output in the economy.

IS curve is not affected with the monetary contraction as it relates to the government spending.

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