Question

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

Short answer

The AD curve will shift to the left when the money supply is reduced, lowering income and price levels.

Step-by-step solution

Step 1. Define AD/AD model.

The aggregate demand–aggregate supply model, often known as the AD–AS model, is a macroeconomic model that examines the relationship between aggregate demand and aggregate supply to explain price level and production.

Step 2. How governments can use monetary policy to decrease the price level?

The AD curve will shift to the left when the money supply is reduced, lowering income and price levels. Banks will be unable to lend as much money as they previously did. Interest rates are expected to rise, affecting consumption and investment, two significant drivers of aggregate demand.