Question

Suppose that the government believes the economy is producing goods and services beyond its optimal level. The government therefore decides to decrease the quantity of money in the economy. This monetary policy____________ the economy's demand for goods and services, leading to____________product prices. In the short run, the change in prices induces firms to produce_________ goods and services. This, in turn, leads to a________level of unemployment. In other words, the economy faces a trade-off between inflation and unemployment: Lower inflation leads to_______ unemployment.

Answer 1

Answer:

1. Reduces

2. Decrease in

3. Less Quantity

4. Increased level

5. Higher level

Explanation:

The challenge with the monetary policy introduced by the government is that it is a contractionary policy. A contractionary monetary policy fights inflation by reducing the money in supply in order to increase the cost of borrowing.

However, the problem with contractionary policy is that once the demands for goods and services decrease, the price of products will go down to entice people to consume and purchase. Once the price of products go down, the manufacturers are demotivated to produce more, hence production will go down.

Once production goes down, people are laid off work, and firms can no longer employ more leading to a higher level of unemployment.

The challenge therefore is that lowering inflation will lead to increased unemployment due to the ripple effects.