Question

1. Starting at Full Employment, explain what happens to output, the price level, and

employment ) in each of these cases and use the AD/AS diagram (use arrows and new

lines) to show the direction of changes

LRAS Price Level SRAS AD GDP

b. Consumers become more pessimistic about the economy

2. Describe the main tools of monetary policy the Federal Reserve uses and how they would use

them if there were a financial crisis to stabilize the economy

3. a) the federal government was required to balance its budgets annually, what

constraints would it have to address the problems arising during a recession?

b) How is a full employment balanced budget different from an annually balanced

budget?

Answer 1

(Question 1)

When consumers become more pessimistic, they reduce consumption. A fall in consumption decreases aggregate demand, shifting AD curve leftward to AD1, intersecting SRAS curve at point B, with lower price level P1 and lower real GDP Y1, causing a short run recessionary gap of (Y* - Y1).

NOTE: As HOMEWORKLIB Answering Policy, 1st question has been answered.