In the long run, what is the effect of a sustained increase in the money supply on real GDP and the price level?

• A. Real GDP rises, price level falls
• B. Real GDP falls, price level rises
• C. Real GDP unchanged, price level rises
• D. Real GDP rises, price level unchanged

Answer: (C)

Long-run money neutrality means that after prices have fully adjusted, the amount of money in the economy affects only nominal variables, not real output. If the money supply grows persistently, the price level rises to restore balance in the goods and money markets while real GDP returns to its natural, potential level set by resources, technology, and institutions. In other words, output stays essentially the same in the long run, but prices rise enough to absorb the extra money, so inflation persists rather than a higher level of real GDP. In the long run, the economy expands production only with real factors; money mainly alters the price level.