Suppose that an economy is in a deep recession.

a. Draw and carefully label an AS/AD diagram that illustrates this case. Label the point representing the state of this economy E0.

b. If no policy action is taken, what will happen to the economy over time? Show on your graph, labeling some new possible equilibrium points E1, E2, and E3. (Think about which curve shifts over time, and why, when the economy stagnates.

Assume that no changes occur in investor or consumer confidence or in the economy’s maximum capacity output level.)

c. Suppose that the changes you outlined in (b)

occurred very rapidly and dramatically. Is government policy necessary to get the economy out of the recession?

d. Write a few sentences relating the above analysis to the dispute between classical and Keynesian macroeconomists.