Use a medium-run aggregate supply curve as opposed to a short-run supply curve. Please draw a large

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Question:

Use a medium-run aggregate supply curve as opposed to a short-run supply curve. Please draw a large enough set of diagrams so that your answers to all parts of this question fit on them.

a) Let us return to 2019. Assume that the US economy is in its long-run equilibrium. Use ADAS and Phillips Curve diagrams to illustrate the equilibrium and label it (1). As always, label all axes, curves, and write model equations.

b) Illustrate the effects of the COVID pandemic on the US economy assuming that the pandemic brought about a negative demand shock. Label new equilibrium (2) and comment on how macroeconomic variables have changed as compared to part A.

c) Suppose that the Fed announces its decision to engage in massive bond purchases. This step has some effect but does not restore the economy to the pre-recessionary level. Illustrate short-run effects of the Fed’s policy on the U.S. economy using your ADAS and Phillips curve graphs. Label the equilibrium (3) and describe the economic intuition.

d) Next, suppose that the negative economic effects of the COVID recession are so persistent that policymakers believe extra stimulus is needed. The Fed continues its expansionary monetary policy and so that the natural rate of output is surpassed. Again, illustrate short-run effects of the Fed’s policy action on the U.S. economy on both ADAS and Phillips curve diagrams and describe how and why the new equilibrium (4) is different from the equilibrium (3).

e) According to the rational expectations Phillips curve model, what would happen to the US economy in the long run? Use the Phillips curve diagram and Phillips curve equation to illustrate adjustment from the old equilibrium (4) to the new equilibrium (5). Describe the intuition. To be clear, you do not need to use the ADAS model for part E. Illustrate your answer to part E on your ADAS model diagram. Explain the intuition for your result.