Use the Following to Answer Questions

question 42

Multiple Choice

Use the following to answer questions .
Exhibit: Responses to a Decrease in Aggregate Demand
-(Exhibit: Responses to a Decrease in Aggregate Demand) The economy is initially in equilibrium at point (1) . Now suppose a reduction in the money supply causes aggregate demand to fall to AD₂. Which of the following explains the new classical view regarding economic agents' response to the decrease in money supply?

• A) Consumers and firms observe that the money supply has fallen and that the price level has fallen to P₂. Consumers respond by increasing their demand for output and firms in turn increase their supply to meet the rising demand. The economy moves back to point (1).
• B) Consumers and firms observe that the money supply has fallen and that the price level has fallen to P₂. To prevent further reductions in the price level, firms increase output at the same time as consumers increase aggregate demand. The economy moves to point (4), bypassing point (3).
• C) Consumers and firms observe that the money supply has fallen and anticipate the eventual reduction in the price level to P₃. They adjust their expectations accordingly. Workers agree to lower nominal wages, and the short-run aggregate supply curve shifts to SRAS₂ at the same time as aggregate demand falls, bypassing point (2).
• D) Consumers and firms observe that the money supply has fallen and anticipate the eventual reduction in the price level to P₄. They adjust their expectations accordingly. Workers agree to lower nominal wages, and the short-run aggregate supply curve shifts to SRAS₂ at the same time as aggregate demand rises, moving the economy to point (4).

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Definitions:

Legal Tender

Coins and paper money officially declared to be acceptable for the settlement of financial debts.

Car Importer

A company or individual that buys foreign cars and brings them into a country to sell.

Drug Trafficking

The illegal trade involving the cultivation, manufacture, distribution, and sale of substances which are subject to drug prohibition laws.

Balance Of Payments

A record of all transactions made between one particular country and all other countries during a specified period, showing the total inflows and outflows of money.