Question

suppose a given economy starts at point a in the figure. if the fed engages in an expansionary monetary policy, what would you expect to happen in the short run?
a) aggregate supply will decrease because of higher wages.
b) the economy will move along the ad curve to a lower inflation rate.
c) aggregate demand will increase because of lower interest rates.
d) aggregate demand will decrease because of higher interest rates.

Explanation:

Expansionary monetary policy by the Fed typically involves increasing the money supply, which leads to lower interest rates. Lower interest rates encourage borrowing and spending, thus increasing aggregate demand (AD). Option a is incorrect as expansionary policy doesn't directly cause aggregate supply to decrease due to higher wages in the short run. Option b is wrong because moving along AD to lower inflation would happen with contractionary policy, not expansionary. Option d is incorrect as expansionary policy lowers, not raises, interest rates. So option c correctly explains that lower interest rates from expansionary policy increase aggregate demand.

Answer:

c) Aggregate demand will increase because of lower interest rates.