The economy in 2013 starts in equilibrium at point A, with real and potential GD

Question

The economy in 2013 starts in equilibrium at point A, with real and potential GDP equal to S14.75 trillion. Between 2013 and 2014, potential GDP increased to $14.93 trillion as the long run aggregate supply curve shifted right to LRAS2. Economists at the central bank project that real GDP for 2014 will be $15.03 trillion. Using this information and the information contained in the graph, answer the following questions. Why might the central bank want to engage in contractionary monetary policy in this instance? They would not want to intervene since aggregate demand is rising. Aggregate demand is not growing fast enough to meet potential GDP. The changes in the price levels indicate that deflation is occurring. Price levels may be increasing too quickly leading to high inflation. Show on the graph what would happen if the central bank conducted a successful contractionary monetary policy. Incorrect. If the central bank engages in a contractionary monetary policy, short-run aggregate supply would not be affected. What other economic variable is the central bank attempting to influence?

Explanation / Answer

1., Price levels may be increasing too quickly leading to high inflation.

2. Shifts the aggregate demand curve to left.

   Explanation:

Contractionary monetary policy decreases the money supply in an economy . The decrease in the money supply is mirrored by an equal decrease in the nominal output, otherwise known as Gross Domestic Product (GDP). In addition, the decrease in the money supply will lead to a decrease in consumer spending. This decrease will shift the aggregate demand curve to the left. This reduction in money supply reduces price levels and real output, as there is less capital available in the economic system.

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