Question

If the monetary authorities decide to increase the nominal money supply by 10% when the economy is at its full-employment level of output, in the long run the aggregate price level increases by _____% and real GDP _____.

10; increases by 10%

5; increases by 5%, according to Okun's law

5; increases by 20%, given a marginal propensity to consume of 0.5

10; returns to the potential level of output

Answer 1

If the monetary authorities decide to increase the nominal money supply by 10% when the economy is at its full-employment level of output, in the long run the aggregate price level increases by 10 % and real GDP returns to the potential level of output.

When the monetary authorities increase the money supply then the surplus with the consumers will increase thus the aggregate price level will also increase. That is change in money supply will increase the price level in the same proportion. Let us assume other things remain constant then

% ∆ Money Supply + %∆ Velocity =%∆Price + % ∆Output

10 % + 0% = %∆ Price + 0%

% ∆ Price = 10%

And the real gdp returns to the potential output level.

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