Your answers should be precise. Do not give information that is not directly relevant to answering the questions. Show all your work for numerical questions and clearly label the diagrams for graph questions to receive full credit. The assignment will be graded on a scale of 0-4. Clarity and grammatical correctness will carry some weight in the evaluation of this assignment.

1. Suppose the economy is initially in long-run equilibrium in the AD-AS model.

a) Draw a diagram showing long-run equilibrium, including the AD, LRAS, and SRAS curves. (1 point)

b) Now suppose stock prices decline sharply. Draw a new diagram showing the AD, LRAS, and SRAS curves. How have the level of output and the price level changed? What happens to consumption spending and investment spending? (1 point)

c) Redraw your diagram from part b, then draw new lines to show what would happen if the Fed changed monetary policy to return the economy to full-employment equilibrium. Does the money supply increase or decrease? Which curve (AD, LRAS, or SRAS) shifts because of the Fed's policy change? What happens to the price level and level of output compared with what they were in part b? What happens to consumption spending and investment spending compared with what they were in part b? (2 points)