Question

Assume that the economy starts at potential output, and then there is a major decline
in new home construction.
a) Describe the short-run impact of this change on real GDP and the price level. Be
specific about what component(s) of GDP change, and explain the economics
behind the changes you describe.
b) Assuming no further shocks/changes in policy, describe how the economy will
transition from the short-run equilibrium in part a) to its long-run equilibrium. Be
sure to explain the economics behind any changes in the economy that you describe,
and the why of each step in the process.
c) Suppose that Congress decides to respond to this shock with fiscal policy. What
goal would they pursue? What two types of actions would they consider? Describe
how each policy would affect real GDP and the price level in the short run. You
don’t need to discuss the size of the policy effects, just their direction – does Y
increase, or decrease? Why? Since this is fiscal policy, be sure to discuss the
multiplier effect

Answer 1

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