Question

A 5 percent reduction in the money supply will, according to most economists, reduce prices 5 percent: A. in both the short and long runs. B. in neither the short nor long run. C. in the short run but lead to unemployment in the long run. D. in the long run but lead to unemployment in the short run.

Answer 1

The correct answer is option D.

Step-by-step explanation:

A reduction in the money supply will cause a reduction in investment. This is because, as the money supply is reduced the interest rate increases. This further cause the cost of borrowing to increase. As a result, the investment will decline.

A fall in investment will cause production to reduce. To produce fewer firms will need fewer workers. Unemployment will increase as a result.

In the long run, though, reduction in production will cause supply to decline. As a result, the supply curve will shift to the left. This causes a reduction in the price.