Question

If a central bank increases the money supply in response to an adverse supply shock, then which of the following quantities moves closer to its pre-shock value as a result?

a. neither output nor the price level

b. both the price level and output

c. the price level but not output

d. output but not the price level

Answer 1

Answer : The answer is option d.

When money supply increase then aggregate demand increase. As a result, the aggregate demand curve shift to rightward. At adverse supply shock situation the aggregate supply curve shift to leftward. As a result, the price level increase and quantity level decrease. Now if Fed increase the money supply then the aggregate demand curve shift to rightward. As a result of this, the price level rise more than before situation and quantity level move closer to the pre-shock quantity level. Therefore, option d is correct.