Question

PLEASE SHOW THE GRAPH

Assume the United States is operating below full employment.

1. Identify one monetary policy tool that will solve the problem.

2. Using a correctly drawn and labeled AD/AS graph and money market graph, show and explain how the policy you identified in (a) will affect each of the following in the short-run:

i. output and employment

ii. price level

iii. interest rates

Answer 1

1)

• Since economy is operating below the full employment level, hence there is scope to increase output and employment opportunities.
• Central Bank must use cheap monetary policy to increase output and employment. Federal Reserve would decrease the Federal Fund Rate to increase money supply. It will make money available at cheaper rate.

2)

i) Output and employment will rise.

ii) There might be small rise in price level but it would be less relatively.

iii) Interest rate will fall due to rise in money supply.

Following is diagram: