Question 6
A)Suppose the economy is in a long-run equilibrium.
A1)[ 3 points] Draw the economy’s short-run and long-run Phillips curves. Using your own words, explain why the short-run and long-run Phillips curves have the slopes that you have drawn in your graph.
A2) [3 points] Now suppose a wave of business pessimism reduces aggregate demand. Using a new diagram, show the effect of this shock.
A3) [3 points] Can the Fed return the economy to its original inflation rate and original unemployment rate through monetary policy? Explain why. Make sure to specify whether you are referring to an increase or a decrease in money supply.
B)Now suppose the economy is back in long-run equilibrium.
B1) [3 points] The price of imported oil rises. Using a new graph, draw the economy’s short-run and long-run Phillips curves.
B2) [3 points] Can the Fed return the economy to its original inflation rate and original unemployment rate through monetary policy? Explain why. Make sure to specify whether you are referring to an increase or a decrease in money supply.
C)[3 points] Explain with words why this situation in part B2 differs from that in part A3.
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