1. The economy of a hypothetical country has been stable for two or three years with very low unemployment. Wages have been gradually increasing during this time. Now stock market prices begin significant increases, causing peoples' investments, such as their retirement accounts and other investments to increase in value. People feel confident about the future. They believe they will keep their jobs, get regular pay raises and life will be good. With this positive feeling, people feel better about making purchases. They now use their new-found sense of wealth to buy many things that they had been hesitant to purchase in the past.

Given this scenario, insert your answers below each of the following questions.

a. What kind of economic gap will start to occur (inflationary or recessionary)?

(Enter your response here.)

b. Which of these graphs, Figure 1 or Figure 2, depicts this economic gap?

(Enter your response here.)

Figure 1

AGGREGATE PRICES P2 P1 0 D1 S1 Real GDP LRAS D2 Q 62 S1 D1 D2