Question

Suppose an economy is characterized by flexible prices and rigid nominal wage in the short-run. Using Aggregate Demand-Aggregate Supply framework, discuss the short-run and long-run effects of a decrease in money supply on the price level, real GDP, nominal wage rate and real wage rate.

Answer 1

In the short-run a decrease in money supply will decrease aggregate demand, so the price level and real GDP will decrease, nominal wage rate will not change and real wage rate will increase.
In the long-run short-run aggregate supply will increase, price level will decrease more, real GDP will increase to the previous level, nominal wage will decrease and real wage rate will decrease to the previous level.