1.Assume the U.S. economy has been operating at output levels beyond full employment.

(a)Draw a correctly labeled graph of aggregate demand and aggregate supply and show each of the following.

a.The long-run aggregate supply curve.

b.The current equilibrium output and price levels, labeled and, respectively.

(b)Assume that no policy action is taken.

a.Show on your graph from part (a) the change in short-run aggregate supply that will return the economy to the natural rate of output. Explain why this happens.

b.Label the new equilibrium output, , and price levels, .

(c)Monetary policy authorities will respond to the change in price level that occurred in part (b). How might the central bank respond to the change you described in part (b)?

(d)Draw a correctly labeled graph of the money market.

a.Label the equilibrium interest rate.

b.Show on your graph the change in money supply that will occur due to the monetary policy described in part (c).

c.Show on your graph the change in interest rates that will occur due to the monetary policy described in part (c).

(e)At the same time, assume that policymakers at the Bank of England enforce an expansionary monetary policy.

a.Using a correctly labeled graph of the foreign exchange market for the U.S. dollar, show how the relative change in interest rates between the U.S. and England will affect the value of the dollar versus the pound. Explain.

b.What effect will this fluctuation have on net exports in the United States?