Question

Show, using the AD/AS model, how governments can use monetary policy to decrease the price level.

Short answer

By adopting contractionary policy.

Step-by-step solution

Step 1. Introduction

Monetary policy refers to the use of tools to influence the level of economy activity by affecting the supply of money. Moentary policy can be expansionary or contractionary.

Step 2. Different monetary policy used by government to decrease the price level.

Contractionary money supply in which government tried to suck excessive money from the market by issuing different government bonds so that the inflation got reduced and price level decreases.

Other tools to reduce money supply are increase in the interest rates, fed funds rate, reserve ration,liquidity ratio, etc.