Question

Given an upward sloping aggregate supply curve, which of the following is most likely to occur if the fed pursues restrictive monetary policy?
a. The equilibrium price level and output will both increase.
b. The equilibrium price level and output will both decrease.
c. The equilibrium price level will decrease but output will stay the same.
d. The equilibrium output will decrease but the price level will stay the same.

Answer 1

Answer:

b. The equilibrium price level and output will both decrease.

Explanation:

If the Fed decides to use restrictive monetary policy money supply to the economy will be reduced. Instruments for reducing money supply is by using interest rate, open market operations, and reserve ratio.

When money supply is reduced, aggregate demand will reduce (shift to the left) because people will have less money to spend. The real output will also reduce because there is reduced demand for goods and services.

Attached is a diagram illustrating this. Equilibrium price moves from A to B, and output decreases from Y1 to Y2