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Consider the scenario in which the Fed is implementing a contractionary monetary policy aimed at alleviating inflationary pressures.In this regard please provide an answer to the questions listed below. In order to answer, it might be a good idea to use a money market diagram and show how interest rates affect the economy using the AD/AS diagram. No need to submit the graphs, but once again drawing the two graphs (money market and AD/AS) for yourself will go a long way in guiding you towards the right answer. Note. In the static AD/AS model, initially assume that the economy is in SR equilibrium and real GDP is above potential GDP. a) As a result of the contractionary monetary policy pursued by the Fed, what would happen with the interest rate? The interest rate is going to (rise/fall/stay fixed) Blank 1 . b) What would happen with the short run aggregate supply curve? Short run aggregate supply curve will shift (left/right/stay fixed) Blank 2 . c) What would happen with the long run aggregate supply curve? Long run aggregate supply curve will shift (left/right/stay fixed) Blank 3 . d) What would happen with the aggregate demand curve? Aggregate demand curve will shift (left/right/stay fixed) Blank 4 . e) What would happen with the Real GDP level? Real GDP will (rise/fall/stay fixed) Blank 5 . f) What would happen with the employment level? Unmployment level will (rise/fall/stay fixed) Blank 6 .

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Retselisitsoe Pokothoane
Retselisitsoe PokothoaneLv10
28 Sep 2019

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Related questions

MBA502, Economics for Business

Apply and Discover 7.2

You are responsible for economic policymaking in your country. Your desire is to eliminate inflation, keeping prices absolutely stable at P = 100, no matter what happens to output. Currently, the economy is in equilibrium at Q = 3200 (where Q = potential GDP) and P = 100. You can use monetary and fiscal policies to affect aggregate demand but you cannot affect aggregate supply in the short run. How would you respond to the following scenarios?

Explain and illustrate how each of these events would affect aggregate demand, aggregate supply, and prices, then explain how you would respond with economic policies.

1. A surprise increase in investment spending

In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index.

To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity.

2. Catastrophic floods that cause a sharp food price increase

In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level.

The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do.

To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates).

3. A productivity decline that reduces potential output

In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines.

Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further.

4. A deep depression in East Asia that causes a sharp decrease in net exports to the United States

A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports

Show transcribed image text

1. Does the Aggregate Demand (AD) curve always slope downward? Discuss and use explanations (interest rate effect, wealth effects, open economy effect).

2. The Aggregate Supply (AS) curve slopes upward to reflect the profit motive of businesses. So, why there are two versions of the AS curve( i.e. short run and long- run). Discuss.

3. Does Aggregate Demand and Aggregate Supply always occur at full-employment level?

a) If yes, will there be some unemployment? Explain

b) If no, then the actual real GDP may be different from the potential real GDP. When the actual and potential GDP are not the same, then the economy is either in a recessionary gap or inflationary gap. Explain

Suppose that the Australian economy is at long run equilibrium, and the Australian government announces its decision to decrease spending on infrastructure.

Discuss the short-run effects of a decrease in spending on aggregate espenditure (AE) and aggregate demand (AD). in your discussion, explain the process that moves the economy to its new equilibrium output. That is, explain what would happen to:

1. aggregate planned expenditure

2. firms inventories and production

3. disposable income and consumption expenditure

4. aggregate demand and supply

5. real GDP and price level

Use the AE and AD Graph for your graphical analysis to support your explanation.

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