Question

Through bond sales, a nation's central bank pulls money out of circulation. One of the short-term effects is to drive the price level from 100 down to 93.7. There are other short-term effects as well, but they fade in the long run, even as the price level drops still further. Model the short- and long-term effects in the graph below by dragging one or more curves to new positions. To refer to the graphing tutorial for this question type, please click here.

Answer 1

Through open market operations Government can fluctuate the money supply in the economy. One of the short-term effects is to drive the price level from 100 down to 93.3. In short run, decrease in money supply will leads to higher interest rate, this will discourage the investors. Thus, investing and spending will fall which will shift the aggregate demand curve leftward.

check the attached file for the curve

In long run adjustment in wages tale place and firm will pay lower wage rate to workers. Since nominal wages will decrease overtime causing the SRAS curve to shift rightward. Because unemployment is created in the short run which decreases wages, so supply increase from SRAS to SRAS (1). Long run equilibrium will attain at (8,87.5).