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Aggregate Demand/Aggregate Supply Model - Money supply

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I'm at work trying to do this problem. Having trouble could you please help me?

To enhance my learning could you please in a step-by-step process how to answer this problem resulting effect on the Aggregate Demand/Aggregate Supply Model? Please explain in simple terms.

Under what circumstances might the Fed want to shrink (contract) the money supply?

Thank-You!

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Solution Preview

The first step in answering this problem is to have a clear understanding of the term money supply. In economics, "money supply" is the total amount of money existing in an economy at a specific moment in time. While there are many ways to define "money", the traditional definition generally considers currency in circulation and demand deposits (the term demand deposits refers to money that is accessible in deposit accounts held at a bank or other financial institution so that the funds may be retrieved on demand). When economists refer to shrinking or contracting the money supply, they are referring to decreasing the amount of hard currency available in an economy. This is achieved through raising the federal discount rate, reducing the monetary base through open market operations, and/or increasing reserve requirements.

The Fed might want to shrink the monetary supply in order to achieve policy goals. In order to understand the policy goal behind a reduction in money supply it is important to first understand the effects of altering the money supply. The direct effect of a decrease in the money supply is that people purchase less goods and services because they have less ...

Solution Summary

This solution reviews in detail the definition of the term money supply, why the Fed might want to shrink the money supply in order to achieve certain policy goals, the purpose of engaging in contractionary policy to close the inflationary gap in an economy, how net exports affects this analysis, and why the Fed fears inflation.

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Economics Questions

The demand for money varies
a. directly with both the price level and the level of real GDP
b. inversely with both the price level and the level of real GDP
c. inversely with the price level and directly with the level of real GDP
d. directly with the price level and inversely with the level of real GDP
e. inversely with the level of nominal GDP

The opportunity cost of holding money
a. includes bank service charges
b. is the interest foregone on potential interest-earning assets
c. varies inversely with the rate of interest
d. affects relatively few individuals
e. is determined exclusively by the Fed

In the aggregate demand-aggregate supply model, a decrease in the money supply will cause in the short run a(n)
a. increase in both the price level and real GDP
b. decrease in both the price level and real GDP
c. increase in real GDP and a decrease in the price level
d. decrease in real GDP and an increase in the price level
e. increase in the price level only

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