Money supply is M divided by the Price level P. We are interested in Reak Money supply not nominal money supply.

AD = Y= C+I+G+(X-M)

3 possibilities

1) Horizontal section is the situation where the economy is at less than full capacity

a) government has the power to spend more : incrases G

B) cut taxes : C increase, and I increases

2) We are in the intermediate part of the curve

a) an increase in G spending is going to incrase Y, but also create inflation : P goes up

3) we are in the vertical part of the curve

What happens if G increases Ad9 moves to the right at AD1, Y stays the same and P increases.

When we are in the vertical part of the supply curve moving to the right only creates inflation.

AD = Y = C + I +G +(X-M)

How does the bank of Canada creates money.

What to banks do with their money? Out of 75000 they can lend 40000. What do they do with the remaining 35000. they have to park it somewhere. Buying government bonds. Bank in the portfolio have a mix of loans and bonds. Bank of Canada will buy back thoses bonds. What does that do. Banks now have more cash, or more deposits.

AD = Y = C + I +G +(X-M)

A decrease in money supply :

shift money supply to the left, increases interest rate, decrease investments, shift the AD to the left, gives a decrease in GDP and a decrease in price level.

AD = Y = C + I +G +(X-M)

An increase in money supply : will lower interest rates, which will increase Investment, which will increase AD, which will increase GDP(if we are not in the vertical part of the supply slope) which will increase Price level.