Which of the following is the immediate and longer-term effect of a decrease in the money supply?
A)A decrease in the money supply creates an excess supply of money that is eliminated by rising prices.
B)A decrease in the money supply creates an excess supply of money that is eliminated by falling prices.
C)A decrease in the money supply creates an excess demand for money that is eliminated by rising prices.
D)A decrease in the money supply creates an excess demand for money that is eliminated by falling prices.

Question

Quizplus · Accepted Answer

A decrease in the money supply creates an excess demand for money, since there is less money circulating in the economy. This leads to a decrease in spending and a decrease in prices in the short term. However, over the longer term, this can lead to a decrease in economic activity and higher unemployment, as businesses and households have less access to credit and are unable to finance investments or purchases. In order to restore equilibrium, either the money supply must increase or prices must fall to match the reduced money supply. Thus, an excess demand for money is only eliminated by falling prices.

Which of the Following Is the Immediate and Longer-Term Effect