(2.0 pts each) An economy is initially in long-run equilibrium. The introduction
ID: 1205244 • Letter: #
Question
(2.0 pts each) An economy is initially in long-run equilibrium. The introduction of an electronic payments system dramatically reduces the demand for money in the economy
a.) What is the short-run impact on prices and output of the new system?
Answer:
b.) What can the central bank do, if anything, to counteract the short-run changes in output and prices?
Answer:
c.) If the central bank does not take any policy actions, what will be the long-run impact of the electronic payments system on prices and output?
Answer:
(2.0 pts each) An economy is initially in long-run equilibrium. The introduction of an electronic payments system dramatically reduces the demand for money in the economy
a.) What is the short-run impact on prices and output of the new system?
Answer:
b.) What can the central bank do, if anything, to counteract the short-run changes in output and prices?
Answer:
c.) If the central bank does not take any policy actions, what will be the long-run impact of the electronic payments system on prices and output?
Explanation / Answer
(a)
As demand for money falls, interest rate decreases. LM curve shifts leftward, leading to lower output.
Lower interest rate results in a short run fall in price level.
(b)
Lower demand for money will cause an excess supply of money. So, Central bank should engage in contractionary monetary policy to decrease money supply. As money supply falls, leading to new equilibrium at which new money supply equals lower money demand, price level is restored but output is still lower.
(c)
In the long run, however, alternate payment policy will leave the aggregate demand unchanged, aggregate supply unchanged and will therefore the original long run equilibrium will be restored.
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