Assume that price level in the ABC Islands, a U.S. trading partner, increases signaling inflation in the ABC Island economy.

1. Using aggregate demand aggregate supply analysis, explain the impact of the increased price level on the United States economy.
2. If the Federal Reserve wants to repair the effects on the U.S. economy noted above, identify a policy action it might undertake.
3. Explain the impact of the Fed action on each of the following:
4. output
5. price level
6. the international value of the U.S. dollar

Assume the economy is operating at the full-employment level of output.

The Federal Reserve decides to decrease the discount rate. Explain how each of the following is impacted as a result of the Fed's action:

Nominal interest rates

Aggregate demand

Price level

Assume the Fed's action is successful in changing the economy. Using a correctly drawn and labeled Phillips curve, show and explain how this policy will affect each of the following as the economy approaches a new equilibrium:

the Phillips curve

the natural rate of unemployment