ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Because real GDP is relatively constant over the short run, an increase in money supply increases aggregate demand, which increases prices. Over the longer term, an increase in the money supply will increase real GDP by increasing aggregate demand.

Detailed explanation-2: -A larger money supply lowers market interest rates, making it less expensive for consumers to borrow. Conversely, smaller money supplies tend to raise market interest rates, making it pricier for consumers to take out a loan.

Detailed explanation-3: -Effect of Money Supply on the Economy The increased business activity raises the demand for labor. The opposite can occur if the money supply falls or when its growth rate declines. Banks lend less, businesses put off new projects, and consumer demand for home mortgages and car loans declines.

Detailed explanation-4: -So the first thing that happens with a decrease in the money supply is that interest rates rise. As interest rates rise, businesses are less willing to invest to borrow for investment spending. And consumers, too, are less willing to borrow to buy cars and homes and so on. Thus spending decreases.