Which of the following best explains expansionary monetary policy in the long ru

Question

Which of the following best explains expansionary monetary policy in the long run (assuming that the economy initialy starts from a long run equilibrium) ?

A. Expansionary monetary policy shifts aggregate demand to the right, moving the economy from long-run equilibrium to a short-run equilibrium with a higher price level and a higher level of real GDP. In the long run, as resource prices rise, the aggregate demand curve shifts back to the left, bringing the economy back to a long-run equilibrium where no real changes to GDP have occurred and the price level is higher.

B. Expansionary monetary policy shifts aggregate demand to the left, moving the economy from long-run equilibrium to a short-run equilibrium with a lower price level and a lower level of real GDP. In the long run, as resource prices rise, the short-run aggregate supply curve shifts to the left, causing the economy to contract and the price level to rise.

C. Expansionary monetary policy shifts aggregate demand to the right, moving the economy from long-run equilibrium to a short-run equilibrium with a higher price level and a higher level of real GDP. In the long run, as resource prices fall, the short-run aggregate supply curve shifts to the right as well, causing the economy to expand and the price level to drop.

D. Expansionary monetary policy shifts aggregate demand to the left, moving the economy from long-run equilibrium to a short-run equilibrium with a lower price level and a lower level of real gross domestic product (GDP). In the long run, as resource prices fall, the short-run aggregate supply curve shifts to the right, bringing the economy back to a long-run equilibrium where no real changes to GDP have occurred and the price level is lower. E. Expansionary monetary policy shifts aggregate demand to the right, moving the economy from long-run equilibrium to a short-run equilibrium with a higher price level and a higher level of real GDP. In the long run, as resource prices rise, the short-run aggregate supply curve shifts to the left, bringing the economy back to a long-run equilibrium where no real changes to GDP have occurred and the price level is higher.

Explanation / Answer

If the economy starts at long-run macroecnomic equilibrium and expansionary monetary policy is administered then in that case this expansionary monetary policy brings down the interest rate which in result increases the consumption and investment demand backed by credit. This increase in consumption and investment leads to increase in aggregate demand and aggregate demand curve shifts to the right. Given the short-run aggregate supply curve, this increase in aggregate demand results in increase in both real GDP and price level. So, in short-run, economy moves to new equilibrium with higher price level and real GDP. However, over time, this rising price level leads to rise in resource prices as contracts gets renegotiated in light of rising prices. This increases the cost of production and decrease the profit margin of firms. This prompts the firms to reduce their production and aggregate supply in economy decreases. This shifts the short-run aggregate supply curve leftwards. This shift remain continue until economy revert back to its potential real GDP. Thus, no real changes in GDP occurs. However, price level is higher.

Hence, the correct answer is option (E).

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.