Final answer:
A large increase in the money supply causes a larger short-run increase in real GDP in an economy with low inflation than in an economy with high inflation. It suggests that the classical model of the price level may not apply in situations with high inflation.
Step-by-step explanation:
In an economy with low inflation, a large increase in the money supply can cause a larger short-run increase in real GDP compared to an economy with high inflation. This is because in an economy with low inflation, there is more room for the increase in money supply to stimulate spending and investment, leading to a boost in real GDP. On the other hand, in an economy with high inflation, there is already a high level of aggregate demand, and a large increase in the money supply may result in inflationary pressures rather than a significant increase in real output.
This situation indicates that the classical model of the price level may not apply in economies with high inflation. According to the classical model, changes in the money supply only lead to changes in the price level and have no substantial impact on real output. However, in an economy with high inflation, a large increase in the money supply can further fuel inflation rather than causing a proportional increase in real GDP, indicating a deviation from the classical model.
Learn more about Money supply and its impact on real GDP in low and high inflation economies