Problem $2$: The Basic AD$-$AS Model $[11$ Points$]$

This is not a mathematical question, but rather we want to see you use the figures in the model

from class to show how the different curves will move around, and give explanations.

Suppose that we begin in an economy that beings in equilibrium, where AD $=$ AS$.$

$6.$ Suppose that the costs of production for firms rise significantly over this period. What

would we expect to happen to Real GDP $($Y$)$ and the price level $($p$)?$ Include a figure with

AD and AS in your explanation. $[3$ points$]$

Now suppose that the government is concerned about Real GDP and wants to return it to its

previous level. The local governing body is also very concerned about inflation, and so are

looking for a strategy that would allow them to both $($i$)$ increase Real GDP and $($ii$)$ reduce

inflation $($i$.$e$.$ the price levels$).$

Suppose that the government suggests increasing Government Spending $($G$)$ as a solution to

this.

$7.$ What will be the impact of this increase in G on the AEF? What will be the impact of this

increase in G on AD and AS$?$ Explain your answer. $[2$ points$]$

$8.$ Will this increase in G achieve their desired goal or increasing Real GDP and reducing

inflation? Explain using a figure with AD and AS$.[3$ points$]$

$9.$ Which curve, AD or AS$,$ needs to change in order to achieve both of the Government$$s

goals? What are some policies that you could imagine might achieve this? $[3$ points$]$