6.02

Assume an economy that is operating above full employment.

A. Draw a correctly labeled aggregate demand and aggregate supply graph and show each of the following:

1. The long-run aggregate supply curve
2. Current price level and output levels, labeled PLe and Ye
3. Full employment output, labeled Yf

B. Identify one fiscal policy action that could resolve the problem.

C. Using your graph in Part A, show the short-run effects of the action you identified on each of the following:

1. Aggregate demand. Explain (use the cause and effect chain you learned in the lesson)
2. Output
3. Price level

D. Using a correctly labeled loanable funds graph, show the effect of the policy you identified in Part B on real interest rates.

E. Given the change in the real interest rate in Part D, what is the impact on each of the following?

1. Investment
2. Economic growth rate. Explain.
3. The international value of the dollar. Explain.

F. Now assume instead that the government takes no policy action to fix the problem identified in part A.

1. In the long run, will the short-run aggregate supply increase, decrease, or remain unchanged? Explain.