show how the short-run model would change with a decrease in domestic money supply, specifically noting...

show how the short-run model would change with a decrease in domestic money supply, specifically noting the impact on domestic interest and the price level

Expert Solution

Decrease in money supply shifts money supply curve leftward, increasing domestic interest rate and decreasing the quantity of money.

In following graph, MD0 and MS0 are initial money demand and supply curves, intersecting at point A with initial interest rate r0 and quantity of money M0. Decrease in money supply causes MS0 to shift left to MS1, which intersects MD0 at point B with higher interest rate r1 and lower quantity of money M1.

Increase in domestic interest rate decreases investment, which decreases aggregate demand. AD shifts left, decreasing price level and lowering real GDP.

In following graph, initial equilibrium is at point A where AD0 (aggregate demand) and SRAS0 (short-run aggregate supply) curves intersect with initial equilibrium price level P0 and initial equilibrium real GDP Y0. Lower investment causes AD0 to shift leftward to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.

Rahul Sunny answered 8 months ago

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