Question

Use AD and AS curves to explain the effects on the equilibrium price level and the equilibrium level of output in the short run.

(a) An expansionary fiscal policy with the economy operating near full capacity.

(b) A contractionary monetary policy during a period of high unemployment and excess industrial capacity.

(c) A strong hurricane destroys energy plants which cause energy prices to increase, assuming that the Fed attempts to keep interest rates constant by accommodating inflation.

(d) The federal government pursues a contractionary fiscal policy while the Fed acts to keep output from falling.

Answer 1

a) This will shift the AD curve to the right and there will be movement along the SRAS curve, and the new equilibrium will be at a higher price level and higher output,

b) This will further reduce the demand in the market and shift the AD curve to the left, the new equilibrium will be at a lower price and lower output, there will be movement along the SRAS curve to the left.

c) This will shift the SRAS curve to the left and AD curve to the left as well due to increase in the interest rate will decrease the investment. The new equilibrium will be at a lower output and undetermined level of output.

d) This will have an ambigous effect on the demand curve, assuming that both the effect cancel each other in the market, the output will remains the same and price will not change.