If the economy is at potential output and the Fed increases the money supply, in the short run the price level will likely:
A) fluctuate randomly.
B) remain the same.
C) decrease.
D) increase.

Question

Quizplus · Accepted Answer

If the economy is already at potential output, an increase in the money supply will lead to an excess supply of money. This will increase spending, leading to a short-run increase in aggregate demand. Since output is at its potential level, the increase in demand will push up the price level. Thus, the correct choice is D, the price level will likely increase.

If the Economy Is at Potential Output and the Fed