Presentation on theme: "Assume that the United States economy is currently in a recession in a short run equilibrium."— Presentation transcript:

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2 Assume that the United States economy is currently in a recession in a short run equilibrium.Draw a correctly labeled graph of a long-run aggregate supply, short-run aggregate supply, and aggregate demand, and show each of the following. (i) Current equilibrium output and price level, labeled as Y1 and PL1 (ii) full employment output, labeled Yf

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3 Assume that the United States economy is currently in a recession in a short run equilibrium.Draw a correctly labeled graph of a long-run aggregate supply, short-run aggregate supply, and aggregate demand, and show each of the following. (i) Current equilibrium output and price level, labeled as Y1 and PL1 (ii) full employment output, labeled Yf LRAS Price Level SRAS PL1 AD Y1 Yf Real GDP

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4 (b) To balance the federal budget, suppose that the government decides to raise income taxes while maintaining the current level of government spending. On the graph drawn in part (a), show the effect of the increase in taxes. Label the new equilibrium output and price levels Y2 and PL2, respectively. LRAS Price Level SRAS PL1 AD Y1 Yf Real GDP

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5 (b) To balance the federal budget, suppose that the government decides to raise income taxes while maintaining the current level of government spending. On the graph drawn in part (a), show the effect of the increase in taxes. Label the new equilibrium output and price levels Y2 and PL2, respectively. LRAS Price Level SRAS PL1 AD Y1 Yf Real GDP

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6 (b) To balance the federal budget, suppose that the government decides to raise income taxes while maintaining the current level of government spending. On the graph drawn in part (a), show the effect of the increase in taxes. Label the new equilibrium output and price levels Y2 and PL2, respectively. LRAS Price Level SRAS PL1 PL2 AD1 AD Y2 Y1 Yf Real GDP

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7 (c) Draw a correctly labeled graph of the short-run and long-run Phillips curves. Use the letter A to label a point that could represent the current state of the economy in recession.

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8 (c) Draw a correctly labeled graph of the short-run and long-run Phillips curves. Use the letter A to label a point that could represent the current state of the economy in recession. LRPC inflation SRPC unemployment

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9 Draw a correctly labeled graph of the loanable funds market for the UDraw a correctly labeled graph of the loanable funds market for the U.S. Label the equilibrium interest rate as r1 and the quantity of funds a qlf1.

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10 Draw a correctly labeled graph of the loanable funds market for the UDraw a correctly labeled graph of the loanable funds market for the U.S. Label the equilibrium interest rate as r1 and the quantity of funds a qlf1. Interest rate Slf r1 D lf Qlf1 Q loanable funds

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11 Draw a correctly labeled graph of the loanable funds market for the UDraw a correctly labeled graph of the loanable funds market for the U.S. Label the equilibrium interest rate as r1 and the quantity of funds a qlf1. Interest rate Slf r1 D lf Qlf1 Q loanable funds

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12 Draw a correctly labeled graph of the loanable funds market for the UDraw a correctly labeled graph of the loanable funds market for the U.S. Label the equilibrium interest rate as r1 and the quantity of funds a qlf1. (i) Assume that the policy makers pursue a fiscal policy to stimulate the economy. They decide to increase spending while holding taxes constant. To fund the increase in spending they will increase borrowing. On your graph in part (d), show the impact of this policy action on the interest rate and quantity of funds. Label the new equilibrium interest rate r2 and the new quantity of funds qlf2. Interest rate Slf r1 D lf Qlf1 Q loanable funds

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13 Draw a correctly labeled graph of the loanable funds market for the UDraw a correctly labeled graph of the loanable funds market for the U.S. Label the equilibrium interest rate as r1 and the quantity of funds a qlf1. (i) Assume that the policy makers pursue a fiscal policy to stimulate the economy. They decide to increase spending while holding taxes constant. To fund the increase in spending they will increase borrowing. On your graph in part (d), show the impact of this policy action on the interest rate and quantity of funds. Label the new equilibrium interest rate r2 and the new quantity of funds qlf2. Interest rate Slf r2 r1 D lf1 D lf Qlf1 Qlf2 Q loanable funds

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14 They will decrease or be crowded outGiven your answer in part (d)(i), how will private sector investment expenditures be affected? They will decrease or be crowded out Interest rate Slf r2 r1 D lf1 D lf Qlf1 Qlf2 Q loanable funds

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15 Instead of using fiscal policy, assume the Federal Reserve uses monetary policy to stimulate the economy. What open-market policy should the Federal Reserve implement? Buy Bonds (ii) Using a correctly labeled graph of the money market, show how the policy in part (e)(i) affects nominal interest rates.

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16 (ii) Using a correctly labeled graph of the money market, show how the policy in part (e)(i) affects nominal interest rates. Sm Sm1 Interest rate r1 r2 D money Qm Qm1 Q money

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17 Using a correctly labeled graph of the money market, show how the policy in part (e)(i) affects nominal interest rates.


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What will be the impact of the policy on the price level? Explain HINT – think about AD/AS --- refer to next slide Sm Sm1 Interest rate r1 r2 D money Qm1 Qm2 Q money

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18 What will be the impact of the policy on the price level? ExplainPrice level increases LRAS Price Level SRAS PL1 AD Y1 Yf Real GDP

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19 (f) Instead of using open market operations, assume that the Federal Reserve targets a new federal funds rate to reach full employment. Should the Federal Reserve target a higher or lower federal funds rate? lower

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