Weve just reviewed the quantity theory, which is a theory that shows how the economy fixed itself in the long run But as economist John Maynard Keynes famously said, In the long run we are all dead Lets bring SRAS back into the model, and play the role of a central banker reacting to a rise in velo...

a b The AD curve returns to its starting point so no new ...

Weve just reviewed the quantity theory, which is a theory that shows how the economy fixed itself

Question:

We€™ve just reviewed the quantity theory, which is a theory that shows how the economy fixed itself in the long run. But as economist John Maynard Keynes famously said, €œIn the long run we are all dead.€ Let€™s bring SRAS back into the model, and play the role of a central banker reacting to a rise in velocity growth.
a. The following diagram shows the economy growing at the potential growth rate with 10% inflation. Illustrate what happens if consumers and investors become more optimistic. Clearly label the new growth rate on the x-axis with the words €œHigh-AD real growth,€ and label the new inflation rate on the y-axis with the words €œHigh-AD inflation.€

b. Once the central banker sees this rise in AD, she decides to fully reverse it with monetary policy. In the graph, illustrate what happens if she does her job €œJust right.€
c. If she does her job €œJust right,€ what will the inflation rate be? Provide an exact number.