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1. Assume that the U.S. economy is in a severe recession with no inflation. PowerPoint PPT Presentation


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1. Assume that the U.S. economy is in a severe recession with no inflation. (a) Using a correctly labeled aggregate demand and aggregate supply graph, show each of the following for the economy. (i) Full-employment. (ii) Current output level.

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1. Assume that the U.S. economy is in a severe recession with no inflation.

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1 assume that the u s economy is in a severe recession with no inflation

1. Assume that the U.S. economy is in a severe

recession with no inflation.

(a) Using a correctly labeled aggregate demand

and aggregate supply graph, show each of

the following for the economy.

(i) Full-employment

(ii) Current output level

(iii) Current price level

2003 Long Free Response Solved


1 assume that the u s economy is in a severe recession with no inflation

(b) The federal government announces a major

decrease in spending. Using your graph in

part (a), show how the decrease in spending

will affect each of the following.

(i) Level of output

(ii) Price level

As government

spending

decreases this

causes AD to shift

to the left, causing

Q and PL to go

down.

AD2


1 assume that the u s economy is in a severe recession with no inflation

(c) Explain the mechanism by which the decrease

in government spending will affect unemployment rate.

As government spending decreases this causes

less consumption and investment in the

economy shifting AD to the left, causing

unemployment to rise

AD2


1 assume that the u s economy is in a severe recession with no inflation

(d) The Federal Reserve purchases bonds through

its open-market operations.

(i) Using a correctly labeled graph, show

the effect of this purchase on the interest

rate.

As interest rates fall, this increases C and I,

causing AD to shift to the right. Qty and PL

increase.

MS

MS2

Nominal

Interest Rate

i

i2

MD

QTY Money


1 assume that the u s economy is in a severe recession with no inflation

(e) Explain how the change in the interest rate

you identified in part (d) will affect each of

the following.

(i) International value of the dollar relative

to other currencies

As U.S. interest rates go down relative

to other countries’ interest rates,

U.S. citizens would “save money” in other

countries, thus increasing the supply of

dollars in the foreign exchange market causing

the dollar to depreciate.

Market for Dollars

S

?/$

S2

P

P2

D

Q

Qty of Dollars


1 assume that the u s economy is in a severe recession with no inflation

(e) Explain how the change in the interest rate

you identified in part (d) will affect each of

the following.

(ii) United States exports

As the dollar depreciates relative to other

countries’ currencies, our exports goods and

services become cheaper relative to other

countries’. Exports increase. (NX ↑)


1 assume that the u s economy is in a severe recession with no inflation

(e) Explain how the change in the interest rate

you identified in part (d) will affect each of

the following.

(iii) United States imports

As the dollar depreciates relative to other

countries’ currencies, their goods and services

become more expensive relative to the U.S.’.

U.S. imports decrease.


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