If the economy is at potential output and the Fed decreases the money supply so that actual output is less than potential output, eventually nominal wages will_____ and short-run aggregate supply will _____.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question

Quizplus · Accepted Answer

When the Fed decreases the money supply, it leads to a contraction in economic activity, causing actual output to fall below potential output. As a result, unemployment tends to rise, putting downward pressure on nominal wages. Over time, as nominal wages decrease, the cost of production for businesses also decreases, leading to an increase in short-run aggregate supply.

If the Economy Is at Potential Output and the Fed