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:

Stock Investments

Financial assets referring to shares purchased in other companies intended for income generation or capital gains.

Cost Method

An investment accounting approach where the investment is recorded at cost and adjusted only for dividends received, not market value changes.

Equity Method

An accounting technique used by a company to record its investment in another company based on the equity it holds in that company.

Net Earnings

Net earnings represent the amount of profit left over after all expenses, taxes, and costs have been subtracted from total revenue.