Question

The long-run response to an increase in the growth rate of the money supply is shown by shifting a. the short-run and long-run Phillips curves left. b. the short-run and long-run Phillips curves right. c. only the short-run Phillips curve left. d. only the short-run Phillips curve right.

Answer 1

As there is a increase in growth rate of money supply , this will shift the LM curve to right in ISLM model , due to which AD curve in AD AS model will shift rightwards and price of economy will rise . As price rises this will increase inflation of economy .

Monetarists have always been critical of this Phillips curve trade-off. They argue that in the long run there is no trade-off as Long Run AS is inelastic. Monetarists argue that if there is an increase in aggregate demand, then workers demand higher nominal wages. When they receive higher nominal wages, they work longer hours because they feel real wages have increased. (their price expectations are based on last year)

However, this increase in AD causes inflation, and therefore, real wages stay the same. When they realise real wages are the same as last year, they change their price expectations, and no longer supply extra labour and the real output returns to its original level. Therefore, unemployment remains unchanged, but we have a higher inflation rate. The short-run Phillips curve shifts rightwards .

Hence ( D ) part is a correct answer