Figure 17-2 -Refer to Figure 17-2. the Economy Is Initially in Equilibrium

question 117

Multiple Choice

Figure 17-2
-Refer to Figure 17-2. 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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