Question

1) Start with an initial AD-AS model with the below full-employment equilibrium. Please label all the axes and the curves. Label the equilibrium as "1".

2) Let's say the Fed would like to use a policy to recover the economy. What kinds of policy the Fed has to use? Please note that the Fed would like to have the full employment equilibrium for the economy. Make sure to indicate the policy's name, the direction of the policy (e.g. increase or decrease of whatever the tools that they are using), the details of the tool, and the details of the channels. You may want to indicate what happens to the economy after the policy as well.

3) After the policy, what happens to which curve(s)? Make sure to show the changes in the above AD-AS model. Indicate the new equilibrium as "2". Show the movement into your graph and explain the change clearly.

4) Therefore, what happens to the equilibrium and the economic condition? Explain all the changes in quantity and price in writing.

Answer 1

1)

2) The fed will expansionary monetary policy to correct the situaiton of the economy. The fed will use any of expansionay monetary policy by which he can increase the money supply in the economy to increase the aggregate demand in the economy. The fed can decrease the reserve requirement ratio or, can buy bonds and securities in an open market operations to increase the money supply. The economy will reach to the full employemnt equilbruim .

3) After the policy, the aggregate demand curve shift to the right to its original aggregate demand curve that is AD* in the above figure when its meet the aggregate supply and reach the full employment equilbrium.

4) The equilbruim will reach to the orginal full employment equilbrium and the price level will increase and rela GDP is increased.