Economic Policy Tools in the AS/AD Model

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Drop Box Assignment 20 Points

1.     Consider an economy that is initially in LONG RUN equilibrium as illustrated in the following graph where LRAS is the long-run AS curve, AD is the aggregate demand curve, SRAS is the short-run aggregate supply curve, and E is the equilibrium price and output.

Answer the questions below assuming the following scenarios:

a. At FULL EMPLOYMENT, what is the effect of the following scenarios on either the Aggregate Demand (AD) curve or the Money Supply (MS)? (6) EX: AD shifts right or MS shifts left
1. Increase in Government Spending
2. Decrease in the Discount Rate
3. Increase in the Personal Tax Rate
4. Decrease in Required Reserve Ratio
5. Open Market Sale by the Federal Reserve
6. Increase in Subsidies

b. At FULL EMPLOYMENT, given the scenarios, determine whether the economy faces a Contrationary Gap or Expansionary Gap and WHY? (6) EX: Expansionary Gap or Contractionary Gap/what is effected
1. Increase in the Discount Rate
2. Increase in Required Reserve Ratio
3. Open Market Purchase by the Fed

c. When the economy is facing a Contractionary Gap, which of the following policy instruments will return the economy to the full employment level of real GDP? (4) EX: Return to Full Employment or further away from Full Employment
1. Increase in the Required Reserve Ratio
2. Open Market Purchase by the Federal Reserve
3. Decrease in the Discount Rate
4. Decrease in Government Spending

 

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c. When the economy is facing an Expansionary Gap, which of the following policy instruments will return the economy to the full employment level of real GDP? (4) EX: Return to Full Employment or further away from Full Employment
1. Increase in the Personal Tax Rate
2. Open Market Sale by the Federal Reserve
3. Decrease in the Required Reserve Ratio
4. Increase in Government Spending

 

 

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