Question

Consider the current situation with the Covid-19 virus and its effects on the US economy.

1. Draw out the AD/AS model starting at the long run equilibrium. Indicate all points and curves on the graph. Find the US Real GDP and CPI as of December 2019 (online). Use these values as the price level and natural rate of output in the long-run equilibrium. (10 points)

2. Explain the supply-side shocks coming from the Covid-19 virus. How would these supply-side shocks affect the AD/AS model from part (1)? Explain in words and graphically how these shocks would affect the macro-economy. Draw and analyze the effect of the shock on the AD/AS model, how does it affect production, unemployment, price level and inflation? (10 points)

3. Explain the demand-side shocks coming from the Covid-19 virus. How would these demand-side shocks affect the AD/AS model from part (1)? Explain in words and graphically how these shocks would affect the macro-economy. Draw and analyze the effect of the shock on the AD/AS model, how does it affect production, unemployment, price level and inflation? (10 points)

4. Illustrate the impact on the AD-AS model when both of these shocks are happening at the same time. What do we know will happen for certain, what is unknown, with respect to price level changes and production changes? (10 points)

5. How has the Federal Reserve responded to these shocks? What type of monetary policy changes have taken place? Explain in words and graphically using the MD/MS model. (10 points)

6. How has the Federal government and Congress responded to these shocks? What type of stimulus package has been passed? Explain. (10 points)

7. Consider the $2 trillion Congress has approved to be spent as a counter-shock to the recessionary pressures.

1. If the marginal propensity to consume is ½, what is size of the multiplier effect? (3 points)
2. If the package needs to be financed by new government bonds, and the result is an increase in interest rates by 0.5%, and investment spending declines by $100 million for each 1% increase in interest rates, what is the crowding out effect? (3 points)
3. What will be the net effect of the stimulus package, considering both parts a. and b.? Which effect dominates and why? (4 points)

8. In a generalized AD/AS model (without specific numbers), illustrate and explain how the changes in monetary and fiscal policy act as a counter-shock to the demand and supply side shocks coming from Covid-19. Draw your model starting from (3) and then include the effects of the (5) and (7) on the graph. (10 points)

9. What is the tradeoff that the government faces when enacting these counter-shock measures? Relate this specifically to the Phillips Curve. (10 points)

Answer 1