Consider the full short-run model (IS-MP-PC). You need to draw a diagram and answer the questions below. The IS-MP-PC Model is a 2-part diagram. The top part contains the IS and MP curves. The bottom part contains the PC curve. In both cases the horizontal axis measures SRO (short-run output).

Begin by depicting the initial equilibrium (year 0). That is, draw the diagram corresponding to a situation where there are no AD shocks (a=0), the Fed sets the real interest rate equal to the MPK (r), and there are no inflation shocks (o=0). Suppose also that the initial inflation rate is 4%, which corresponds to the Fed's target inflation rate. Label the initial equilibrium as point A in the diagram, both in the top and bottom parts of the diagram. Which of the statements below is correct regarding year 0?

At the initial equilibrium, both SRO and the real interest rate will be equal to zero.

At the initial equilibrium, SRO will be zero and the inflation rate will be stable at 4%.

At the initial equilibrium, SRO will be zero and the inflation rate will be stable at 2%.

At the initial equilibrium, the real interest rate will be equal to the MPK and the inflation rate will be stable at 0%