Question

Suppose a supply shock shifts the aggregate supply curve from AS1 to AS2, and decreases output below full employment. If the Fed then decreases the money supply, it will Group of answer choices decrease the price level and shift the aggregate demand curve to the right until output returns to its full-employment level stabilize the price level and return output to its full-employment level stabilize the price level, but cause a further decline in output increase both output and the price level return output to its full-employment level, but at the expense of an increase in the price level

Answer 1

Answer: Stabilize the price level, but cause a further decline in output

Explanation:

If the Fed decreases the money supply, there will be less money in the economy therefore people will demand goods and services less.

This will shift the Aggregate demand curve to the left where it will intersect with the AS2 curve at a price level lower than the price level as a result of the supply shock thereby stabilizing the price level.

This would however, result in a further drop in output as there is now less demand for goods so suppliers will produce less.