1. Assume the economy of the United States is operating below the full-employment level.

(a) Draw a correctly labeled graph of long-run aggregate supply, short-run aggregate supply, and aggregate demand, and show each of the following.

(i) Current equilibrium output and price level, labeled as Y1 and PL1

(ii) Full-employment output, labeled as Yf

(b) Assume the Federal Reserve Bank decides to push the output to the full employment level.Describe two actions the Federal Reserve Bank could take.

(c) Given the Federal Reserve action you identified in part (b), draw a correctly labeled graph of the money market and show the effect on the nominal interest rate.

(d) Assume the policy makers decide to use fiscal policy rather than monetary policy to correct the recessionary gap (b).Assume that the marginal propensity to consume is 0.75 and the value of the recessionary gap is $400 billion.

(i) If the government changes its spending without changing taxes to eliminate the recessionary gap, calculate the minimum required change in government spending.

(ii) If the government changes taxes without changing government spending to eliminate the recessionary gap, will the minimum required change in taxes be greater than, smaller than, or equal to the minimum required change in government spending in part (d)(i) ? Explain.

(e) Assume the federal budget must move into deficit in order to fund the measures to close the recessionary gap.

(i) Draw a properly labeled loanable funds market graph showing how the federal budget deficit financing would affect the equilibrium interest rate.

(ii) Based solely off the interest rate change identified in part (i), what will happen to the purchases of foreign assets of people in the United States?