Question

Economics:

1) Why is it possible to change real economic factors in the short run simply by printing and distributing more money?

2) Explain why a stable 5% inflation rate can be preferable to one that averages 4% but varies between 1-7% regularly.

3) Explain the difference between active and passive monetary policy.

4) Suppose the economy is in long-run equilibrium, with real GDP at $16 trillion and the unemployment rate at 5%, Now assume that the central bank unexpectedly decreases the money supply by 6%.

a. Illustrate the short run effects on the macro-economy by using the aggregate supply-aggregate demand model. Be sure to indicate the direction of change in Real GDP, the Price Level and the Unemployment Rate. Label all curves and axis for full credit.

5) Suppose the economy is in long-run equilibrium, with real GDP at $16 trillion and the unemployment rate at 5%. Now assume that the central bank increases the money supply by 6%.

a. Illustrate the short-run effects on the macro-economy by using the aggregate supply-aggregate demand model. Be sure to indicate the direction of change in Real GDP, the Price Level, and the Unemployment Rate. Label all curves and axis for full credit.

Answer 1

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1.

This is because money is neutral in the long run and real variables become equal to nominal variables, after market adjustments take place.

In case of short run, price affects the market and thus real variables. By printing more money, money supply in the economy increases, which shifts the money supply curve to the right, leading to an increase in the price level.

Since real variable = nominal variable / price level,

An increase in price level in the short run due to increase in money supply would bring down the value of real variables.

However, in the long run since money is neutral, there is no effect on real or nominal values.