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problem_set_3(mit) - potential GDP e There is a boom in the...

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Nick Poggetti Economics 2 Problem Set 3 1. Explain what happens to the inflation-adjustment line in the long run (whether it shifts up or down) in each of the following cases. a) The economy sinks into a recession. The IA shifts down and continues to shift down until real GDP is back to potential GDP. b) Firms expect the Fed will adjust monetary policy and allow inflation to rise from 2 percent to 4 percent. The IA line will shift up due to increased expectations of inflation. c) OPEC (Organization of Petroleum exporting countries) successfully doubles the price of oil in the market. The IA line will shift up, since oil is a raw material. d) Congress cuts taxes. The IA line will shift up because the tax cuts will put more cash back into consumers’ pockets which will make the AD curve shift right and then the IA line must shift up until real GDP equals
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Unformatted text preview: potential GDP. e) There is a boom in the economy. The IA line will shift up until real GDP equals potential GDP, for similar reasons as the question above. 2. Suppose the economy is initially at potential GDP. a. Draw an aggregate-demand curve and inflation-adjustment line, and label the initial equilibrium with an A . b. Suppose there is a change in monetary policy that aims to increase the rate of inflation (from the current rate). Illustrate the short-run effect on your diagram. Label the new equilibrium with a B . c. Illustrate the medium-run effect of the change on your diagram, and label the medium-run equilibrium with a C . d. Illustrate the long-run effect of the change on your diagram, and label the long-run equilibrium with a D. e. Is the rate of inflation at point D higher or lower than at point A?...
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