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

Question

Quizplus · Accepted Answer

When the Fed decreases the money supply, in the short run, interest rates tend to rise and aggregate demand falls. As a result, there is downward pressure on prices. In the long run, however, output returns to potential levels and prices will ultimately adjust downward to match the decrease in money supply. Therefore, the correct choice is C, prices will decrease.

If the Economy Is at Potential Output and the Fed