Question

According to the aggregate demand and aggregate supply model, in the long run an increase in the money supply leads to a. increases in both the price level and real GDP. b. an increase in real GDP but does not change the price level. c. an increase in the price level but does not change real GDP. d. no change in either the price level or real GDP.

Answer 1

Answer: Option (c) is correct.

Step-by-step explanation:

In the long run, an increase in the money supply will lead to increase the aggregate price level but doesn't affect the real GDP.

In the short run, an increase in the money supply will create demand in an economy, as a result aggregate demand increases and shifts rightwards. Therefore, both aggregate price level and aggregate output level increases. Aggregate output is above the potential output.

Hence, nominal wages increases over time and this will cause a shift in short run aggregate supply curve leftwards. This process is stopped when the potential output level is achieved. So, in the long run, aggregate price level rises and no change in the real GDP.