Question

3. An economy is initially at a long run equilibrium (GE).

A. On the AD-AS graph, show the AD, LRAS and SRAS curves/lines. Label this “A”

B. The Central Bank (Federal Reserve) increases the money supply. Give one action the Fed can take to increase the money supply.

      _________________________________

Show how this changes the AD-AS graph. Label the curve/line that shifts with a “2” and label the new equilibrium “B”

      There is no additional policy action:

C. Show the transition over time if no other action is taken. Label the curve/line that shifts with a “3”. And label the new equilibrium “C”

D. Over the long run, what is the change in output, unemployment an price level? Circle below.

      Output is (greater than, less than, the same as) the original output level

      Unemployment is (greater than, less than, the same as) the natural rate of unemployment

      Price level is (greater than, less than, the same as) the original price level

Answer 1

Fed can decrease reserve requirement to increase the money supply. This increases loan giving a capacity of banks and hence money supply increases.

This increases aggregate demand and AD curve shifts to right.

In long run

Output is (greater than) the original output level

      Unemployment is ( less than) the natural rate of unemployment

      Price level is (greater than) the original price level