Based on factors like the existing workforce, productive technology, resources, and knowledge, the current level of potential output for our country is estimated at $15 trillion. Despite this, estimates indicate that our current real GDP is actually at $12 trillion.

a) Suppose the government does nothing to intervene in the situation. what would we expect to see over time? What would the ultimate long run result be in terms of equilibrium aggregate output and the aggregate price level?

b) Now suppose the government decides to intervene by focusing on closing the output gap.

i) Suppose that economists agree that the output gap was caused by an AD shock.

• Should the government close the output gap?
• compare the result under government intervention with the alternative of letting the economy run its course

ii) Suppose that economists agree that the output gap was caused by a SRAS shock. (Assume there's no change to LRAS). Further suppose that inflation has been sufficiently high to cause problems in the economy

• Should the government close the output gap?
• compare the result under government intervention with the alternative of letting the economy run its course