1. The U.S. economy is in short run equilibrium with an output level less than the full employment level.
(a) On a correctly labeled graph, show AD, SRAS, LRAS, actual GDP, potential GDP and the equilibrium price level.
(b) Now suppose the U.S. government increases its spending by making three new Star Trek movies.
On a graph, show the effect on AD, SRAS, LRAS, actual GDP, potential GDP and the equilibrium price level.
(c) On a correctly labeled graph of the Phillips Curve, show the effect of this increased spending in the short run and briefly explain your answer.
2. (a) What is stagflation?
(b) How do we end a stagflationary episode in a country? [Hint: Stagflation means high inflation and unemployment at the same time.
So in order to end stagflation, you need to lower the price level AND raise the output simultaneously. Think of how that can be achieved using a combination of different government policies.
3. (a) Suppose that a bushel of wheat costs $3 in the U.S. and 20 pesos in Mexico.
If the nominal exchange rate is 10 pesos per dollar, then what is the real exchange rate?
(b) Continuing from (a), how will (i) the formation of the NAFTA and (ii) the war on Mexican drug cartels affect the exchange rate? Discuss briefly.