Final answer:
Changes in the proportion of indexed contracts can affect the impact of monetary policy on economic activity. A larger proportion of indexed contracts can help maintain the standard of living despite inflation, while a smaller proportion can lead to a decrease in standard of living. The impact of monetary policy on economic activity may be dampened or more pronounced depending on the proportion of indexed contracts.
Step-by-step explanation:
Changes in the proportion of contracts that are indexed can affect how a given change in monetary policy affects economic activity. If a larger proportion of contracts are indexed, it means that wages rise when prices rise. This helps to maintain the standard of living because people can buy the same amount with their wages despite inflation. On the other hand, if a smaller proportion of contracts are indexed, wages may not rise with inflation, causing a decrease in standard of living.
When there is a change in monetary policy, such as an increase in government spending or a decrease in the money supply, it affects the aggregate demand (AD) curve. If a larger proportion of contracts are indexed, the impact of the change in monetary policy on economic activity may be dampened. For example, if government spending increases and the AD curve shifts to the right, a larger proportion of indexed contracts means that wages will rise, offsetting the increase in prices and preserving the standard of living. On the other hand, if a smaller proportion of contracts are indexed, the impact of the change in monetary policy may be more pronounced.