Recall the quantity equation-use liquidity preference

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Recall the quantity equation, MV = PY. In the Classical framework using the quantity equation, a 5% increase in M causes a 5% increase in P without affecting Y. Bearing in mind the effect of a decrease in interest rates on investment spending and real GDP (Y), use Liquidity Preference and AS/AD, explain why a 5% increase in M will cause less than a 5% increase in P in the short run. Assuming the economy was at full employment before the money supply increase, use AS/AD analysis to explain why the full 5% increase in P will occur in the long run.

Reference no: EM131112343

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