Question -
According to the prediction of the economic research department of the Central Bank at the end of 2018, the macroeconomic situation next year (2019) is given in the following table, if neither the Central Bank nor the Treasury Department uses macroeconomic (monetary or fiscal) policy to affect the economy. The information in 2018, which is assumed to be known accurately, is also given.
|
Year
|
Potential Real GDP
|
Real GDP
|
Price Level
|
|
2018
|
$17.8 trillion
|
$17.8 trillion
|
140
|
|
2019
|
$18.3 trillion
|
$18.5 trillion
|
146
|
(a) Draw dynamic aggregate demand and aggregate supply curves to illustrate the information in the above table. The AD (aggregate demand), SRAS (short-run aggregate supply) and LRAS (long-run aggregate supply) curves for both years should be shown in your graph. Clearly indicate the short-run equilibrium and long-run equilibrium for each year.
(b) If the government (Central Bank and/or the Treasury Department) wants to keep GDP as close as possible to potential output in 2019 as well as to deliver an environment more favorable to private investment, what macroeconomic policy should be used? Why? (2 marks) Briefly describe how this policy will change other economic variables to bring real GDP to its potential level.
(c) Suppose that the government's policy in part (b) is successful in keeping real GDP equal to potential output in 2019. Use the dynamic AD-AS model to illustrate the effect of the macroeconomic policy on real GDP and the price level.
(d) If the government does not take any action, discuss how the economy will adjust to its long-run equilibrium, assuming that there is no further shock to the economy in the next few years.