Question

3. The long-run effects of monetary policy 

The following graphs show the state of an economy that is currently in long-run equilibrium. The first graph shows the aggregate demand (AD) and long-run aggregate supply (LRAS) curves. The second shows the long-run and short-run Phillips curves (LRPC and SRPC).

Which of the following statements are true based on these graphs? Check all that apply 

• The natural level of output is $3 trillion. 

• The unemployment rate is currently 6% higher than the natural rate of unemployment. 

• The current quantity of output is greater than potential output. 

Suppose the central bank of the economy decreases the money supply 

Show the long-run effects of this policy on both of the graphs by shifting the appropriate curves.

The long-run effect of the central bank's policy is_______  in the inflation rate, _______  in the unemployment rate, and _______  in real GDP.

Answer 1

MCQ, option a & c are right .

LRAS curve is vertical at Potential- natural level of output, which is $ 3 trillion

At potential GDP level, LRAS cuts the AD curve

LRPC is vertical at natural unemployment rate, which is 6% .

Graphs:

LRAS AD new eqm LRAS AD new AD OUTPUT (Trilions of dollars)

SRPC new eqm SRPC new SRPC 10 12 (Percent

In long run , AD will shift down, as contractionary monetary policy is followed, no change in AS curve, so real GDP unchanged at 3 trillion.

SRPC will shift down, LRPC is unchanged , vertical at 6% .

Thus inflation rate falls,

& No change in unemployment rate

& No change in GDP level