Answer to Question #274883 in Microeconomics for Ankit

Question

Explain using AS-AD model how the output eventually returns to the natural level in the medium-run, in response to a contractionary monetary policy.

Answer 1

A contractionary monetary policy will shift the aggregate supply curve to the left. For instance, the supply of loanable funds shifts the supply to the left from the original aggregate supply curve leading to an equilibrium with a higher interest rate and quantity of funds loaned . AD curve will also shift to the left and the demand decreases. The new equilibrium attained is in the medium run.