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Unformatted text preview: Review for final challenge: Solutions Eco 212 Short answer questions (1-2 sentences) Question 1 Neutrality of money states that changes in monetary policy have no effect on real variables. Doubling the amount of money in the economy may lower short term interest rates, but in the long run it amounts to replacing green one dollar bills with red two dollar bills. We would expect prices to double, but no other changes. Alternatively, in the short run firms and households may be confused and interpret the increase in prices as increases in the value of goods. In the long run however, firms and households eventually learn the true value of goods and services. Question 2 a. A decrease in G financed by lower taxes implies a decrease in spending and therefore a recession. In the long run inflation falls as aggregate demand is less than potential. b. A increase in government spending also increases total spending, causing a boom. c. A decrease in G financed by borrowing implies a decrease in spending and therefore a recession. In the long run inflation falls as aggregate demand is less than potential....
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