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2. Policy effects in an open economy The following graph shows various aggregate demand and aggregate supply curves for the United States. This question will analyze the effect of either fiscal or monetary policy on an economy with mobile capital and floating exchange rates. AS2 AS E PRICE LEVEL F AD 3 C A AD AD 2 REAL GDPSuppose the government decides to cut taxes. Fill in the following paragraph to indicate the effects of such a policy in an open economy. Because this is an expansionary V fiscal policy, aggregate demand will increase V , which leads to a rise V in both real GDP and the price level. In a closed economy, this is the total effect of such a policy. However, in an open economy, it is necessary to consider effects of changes in interest rates and thus the exchange rate. Since this kind of scal policy decreases V interest rates, American securities become less V attractive to foreign investors. This currency appreciates V , causing aggregate demand to decrease V and aggregate supply to increase v . Given the information presented in the summary paragraph, determine which aggregate demand curves must be the initial AD curve, the new AD curve if the economy is closed, and the new AD curve if the economy is open. (Hint: The number labels on the graph are for identication only and do not imply any particular order of shifts.) Fill in the following table with your results. Assume that each curve (AD1, ADz , and AD3 ) should be selected only once. AD Curves AD1 ADz AD3 Original demand 0 New demand, if the economy is closed 0 New demand, if the economy is open O Now complete the same analysis for the aggregate supply curve. Note here that each curve (A51 and A82) may be selected more than once. AS Curves AS; AS1 Original supply 0 New supply if closed economy 0 New supply if open economy O In an open economy, this kind of fiscal policy moves the economy from point to point El