Please show graphically how a contractionary money supply affects the economy.What is the answer to 3. b) http://postimage.org/image/7tin4duxj/

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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There is no way to actually draw graphs on eNotes for questions like these.  However, you can follow this link to find (just scroll down a little) graphs that show this process.

Graphing this process requires two graphs.  On one of the graphs, you need to have the interest rate on your vertical axis and the amount of money demanded and supplied on your horizontal axis.  You need to have a vertical line that represents the money supply.  Finally, you need a line that slants downward from left to right and represents the demand for money.  The point where these lines intersect is, of course, the equilibrium quantity supplied and demanded and the equilibrium interest rate.  When the money supply decreases, it is represented by a movement of the vertical line to the left.  When that happens (with your demand curve remaining as is), you get a higher interest rate and a lower amount of money supplied and demanded.  This reduces aggregate demand.

The second graph has the price level on its vertical axis and Real GDP as its horizontal axis.  There is an aggregate supply curve that is typically horizontal for a bit, slanting upward for a bit, and vertical at the end.  There is an aggregate demand curve that is slanting downward from left to right.  When aggregate demand decreases (this happened in the first graph and this graph is being used to show its impact), the equilibrium point moves to the left.  If the central bank is engaging in contractionary monetary policy, the original equilibrium is most likely in the vertical range of the aggregate supply curve.  If this is the case, a reduction in aggregate demand will lead to a lower price level without any drop in real GDP.

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