Question

Part 1: Assume the inflation rate is high in the economy. Using the infinite line tool, draw the initial economy in long-run equilibrium. Label the short-run demand curve AD1, the short-run supply curve SRAS1 and the long-run supply curve LRAS1. Be sure to plot the initial equilibrium using the double drop line tool and label it E1.

Part 2: Now use the copy tool to demonstrate the long run price level adjustment to a money supply increase. Label the curves you draw accordingly. Then plot the resulting equilibrium using the double drop line tool and label it E2.

Answer 1

Part1.

Part 2.

After expanded monetary policy, the demand will increase and cause inflation in the economy. The new demand will be AD2. At a higher price and higher output.  

IN the short run the price will be a P2 and inflationary gap in the economy.

In the long run, the supply will increase and the price will be even higher after the expansionary monetary policy.

In the long run, the new equilibrium will be at a higher point P3.