QUESTION 1

Consider the AD-AS model that we have discussed in chapter 10.

Assume that the real long-run output of WuYu Island is 3,000, while current price level is at P = 1.0. Suppose that the aggregate demand curve is given by Y = 2(M/P) and M = 1,500.

a)Show that the WuHu economy is (or is not) at its long-run equilibrium.

b) If M increases to 2,000, what are the new short-run values of P and Y?

c) Once the economy adjusts to its long-run equilibrium with M = 2,000, what are P and Y?

d) Neatly sketch the AD and AS curves from parts a-c. Make sure to carefully label the axes, curves, and the short-run and long-run points from above.

e) Using the information and diagram from parts a-d, explain the meaning of monetary neutrality

QUESTION 2

Consider the AD-AS model that we have discussed in chapter 10.

Assume that the real long-run output of RenduJ Island is 3,000, while current price level is at P = 1.0. Suppose that the aggregate demand curve is given by Y = 3(M/P) and M = 1,000.

a)Show that the RenduJ economy is (or is not) at its long-run equilibrium.

b)Now suppose a supply shock moves the short-run aggregate price level to P = 1.5. What are the new short-run P and Y?

c)If the aggregate demand curve and long-run aggregate supply curve are unchanged, what are the long-run equilibrium P and Y after the supply shock?

d)Suppose that after the supply shock the Fed wanted to hold output at its long-run level. What level of M would be required? If this level of M were maintained, what would be long-run equilibrium P and Y?