Question

suppose that companies in the usa come up with a new gadget that is very populat abroad, so the usa experiences a large increase in net exports (nx), thus increasing ad with it. if the fed wanted to stabilize output (meaning bring it back to its original position) in the as/ad model, it could a. increase the money supply, which will reduce interest rates. b. decrease the money supply, which will reduce interest rates. c. increase the money supply, which will increase interest rates. d. decrease the money supply, which will increase interest rates

Answer 1

Option (d) is the correct response: decrease the money supply, which will increase interest rates and subsequently stabilize output in the AS/AD model.

Step-by-step explanation:

If companies in the USA experience an increase in net exports, leading to an increase in aggregate demand (AD), the Federal Reserve (Fed) might want to stabilize economic output by preventing the economy from overheating. The appropriate action for the Fed would be to carry out a contractionary monetary policy to bring AD back to its original level. The Fed could accomplish this by decreasing the money supply, which would increase interest rates. Higher interest rates generally lead to reduced investment and consumption, thereby shifting the AD curve to the left and potentially bringing output back to its long-run equilibrium without causing inflation.

Option (d) is the correct response: decrease the money supply, which will increase interest rates and subsequently stabilize output in the AS/AD model.