Given the usual Lucas supply curve and aggregate demand positively correlated with the real money supply, a sudden reduction in the money supply should cause
A) output to fall while prices remain the same.
B) output to fall while prices increase.
C) output to rise while prices increase.
D) output to fall while prices fall.
E) output to remain the same while prices decline.

Question

Quizplus · Accepted Answer

A sudden reduction in the money supply would lead to a decrease in aggregate demand. According to the Lucas supply curve, which incorporates expectations about prices, this would initially cause output to fall. As demand falls, prices would also decrease due to the lower demand for goods and services.

Given the Usual Lucas Supply Curve and Aggregate Demand Positively