Answer to Question #279663 in Macroeconomics for Kaju

Question

Using AS-AD framework, analyze the impact of an increase in money supply (one time) on output and price level both in short run and medium run

Answer 1

When there is an increase in money supply, in the short run there is a decrease in interest rates and unemployment rates which expands the aggregate supply. As purchasing power increases the aggregate demand curve shifts rightwards from AD to AD'. B represents the new short run equilibrium where price and output are higher than prior to the money supply increase (P' > P and Y' > Y).

Since the money supply increase is one time, in the medium run, the unemployment rates rise which results in reduced aggregate supply of output. This causes the aggregate supply curve to shift upwards from AS to AS' with the medium run equilibrium at point C where the equilibrium price is higher with output back to initial levels (P'' > P' > P and Y'' = Y).