What happens to the level of output and the price level in the short run and in the long run? First describe what should happen and then calculate the precise numerical answer.

        In the short run, it is assumed that the level of price is fixed and the curve of aggregate supply is flat. Hence, the output increases in the short run when Fed increases the money supply but the level of price remains same. In the long run, the curve of aggregate supply is horizontal that shows level of price is flexible and so increase in money supply will increase the prices and output eventually backs to potential output.

    Since it is assumed that 𝑉 = 𝑉̅, the effect of 7% increase in the money supply can be quantified in numerical terms. The quantity equation can be expressed in in terms of percentage change as:

Since the level of price is fixed in short run:

Thus,

Thus the 7% increase in money supply in short run leads 7 percent increase in level of output.

On the other hand, in the long run, the level of price is flexible and the economy is stable at natural output rate. Hence.

Thus,

Thus the 7% increase in money supply in the long run leads 7 percent increase in level of price.