Final answer:
An increase in the money supply can result in a temporary rise in both the price level and output, leading to short-term economic growth and decreased unemployment.
However, the long-term effect does not permanently change the output due to inflationary pressures that lead to price level adjustments.
So, the correct answer is C. permanently, temporarily.
Step-by-step explanation:
When the Federal Reserve decides to increase the money supply at an increasing rate, several short-term and long-term effects can be observed on GDP, unemployment, and inflation.
In the short term, an increase in the money supply can lead to lower interest rates, which encourages borrowing and spending, thereby increasing aggregate demand. This increased demand can boost real GDP and temporarily reduce unemployment.
As businesses see increased demand, they tend to produce more goods and services, which may lead to hiring more workers. However, over time, the increased money supply can lead to inflationary pressures as the price of goods and services starts to rise, eventually decreasing the purchasing power of money.
In a neoclassical view, while short-term effects are evident, the economy tends to adjust and the impact on output and unemployment levels will be neutral in the long run.
Therefore, an increase in the money supply increases the price level temporarily but does not permanently affect the output. Hence, the correct answer to the student's question would be: An increase in the money supply increases the price level temporarily, and output temporarily, which corresponds to option A. temporarily, temporarily.