money neutrality is a characteristic of the aggregate demand-aggregate supply model in:
a) the long run but not in the short run
b) neither the short run nor the long run
c) the short run but not in the long run
d) both the short run and the long run
The correct answer and explanation is:
The correct answer is a) the long run but not in the short run.
Explanation:
Money neutrality refers to the concept that changes in the money supply only affect nominal variables (like the price level) and have no impact on real variables (such as output or employment) in the long run. This idea is a fundamental assumption in classical economics, which is reflected in the aggregate demand-aggregate supply (AD-AS) model.
In the long run, money is neutral because the economy is assumed to adjust fully to changes in the money supply. In the long run, wages, prices, and other input costs can adjust to changes in the money supply, so any increase in the money supply only leads to a proportional increase in the price level, with no change in real output or employment. This is because real variables are determined by factors like technology, labor, and capital, not the money supply.
In the short run, however, money is not neutral. Changes in the money supply can affect real variables like output and employment due to sticky wages and prices. In the short run, wages and prices are slow to adjust to changes in the economy, meaning that an increase in the money supply can temporarily boost aggregate demand, leading to higher output and employment. This is why the short-run aggregate supply curve is upward sloping, as prices and wages do not immediately adjust to shifts in demand.
Thus, while money neutrality holds in the long run, it does not apply in the short run. In the short run, changes in the money supply can influence the real economy, but in the long run, the effects are purely nominal.