Final answer:
An increased money supply shifts the aggregate demand curve rightward, potentially raising both output and price levels, but also leading to inflation. The rational expectations hypothesis posits that this can cause a quicker leftward shift of the SRAS curve, mitigating any real GDP growth. The aggregate demand/aggregate supply model is essential for understanding and addressing macroeconomic issues.
Step-by-step explanation:
Impact of Money Supply on Aggregate Demand and Aggregate Supply
An increase in the money supply typically leads to higher aggregate demand (AD). This increase occurs because with more money in the economy, consumers and businesses are able to spend more, which boosts demand for goods and services. The initial effect of an increased money supply is the rightward shift of the AD curve, suggesting higher output (real GDP) and price levels in the short term.
This expansion in aggregate demand can lead to what is known as an inflationary gap, where the demand for goods and services exceeds the economy's productive capacity. As a result, upward pressure is placed on wages and prices, which can shift the short-run aggregate supply (SRAS) curve leftward to SRAS2 as costs of production rise. In the context of the rational expectations hypothesis, it is suggested that if economic agents anticipate inflation due to the increased money supply, they will adjust their behavior accordingly, potentially leading to a quicker shift of the SRAS curve and nullifying the stimulus effect of the increased money supply in terms of real GDP.
The aggregate demand/aggregate supply model is crucial for understanding the overall performance of the economy and for formulating economic policies targeting growth, unemployment, and inflation. Changes in the money supply are a key element affecting this model, influencing the balance between total supply and demand in the economy.