2. The U.S. economy experienced large trade deficits in the 1980s and 1990s and

tremendous economic growth in the mid- and late-1990s.

A. Trade deficits have an effect on inflation. Explain the relationship between

trade deficits and investment verbally and mathematically using the concept

of the balance of payments.

B. Explain verbally the relationship between investment and long-term

economic growth, and describe the relationship graphically in an AD/AS

graph.

C. Many people believe trade deficits are a serious problem and need to be eliminated.

I. Explain the three actions the Fed could take to reduce the trade deficit in

the United States, and explain carefully how these actions would result

in a reduced trade deficit.

II. What effect would these three actions from part i of the question have on

GDP? Describe the effects on each of the components of aggregate

demand. Include an AD/AS graphical analysis of your answer.