If you increase the rate of growth in the money supply while the economy is at potential output, what happens in the long run?

• A. Interest Rates Only
• B. Real Output and the Price Level
• C. Real Output Only
• D. The Price Level Only

Answer: (D)

When the economy is at potential output, money primarily affects prices in the long run rather than real output. If the money supply grows faster, aggregate demand rises in the short run, nudging up output briefly, but as prices and wages adjust, real GDP returns to its potential level. What stays higher is the price level, reflecting higher inflation and a higher overall price for goods and services. This illustrates the idea that money is neutral for real variables in the long run—the only persistent change is the price level. So the long-run outcome is an increase in the price level with real output remaining at potential.