FRQ 1:

Assume the economy of Artland is currently operating above full employment.

(a) Draw a correctly labeled graph of the short-run aggregate supply, long-run aggregate supply, and aggregate demand curves, and show each of the following.

(i) The current equilibrium real output and price level, labeled as Y1 and PL1, respectively

(ii) The full-employment output, labeled as Yf

(b) Assume the central bank and the government do not take any policy actions to close the output gap.

(i) On your graph in part (a), show how the economy automatically adjusts in the long run and label the new equilibrium price level PL2.

(ii) Explain the cause of the adjustment shown in part (b)(i).

(c) Alternatively, suppose the government wants to close the output gap using fiscal policy.

(i) Identify a fiscal policy action the government could implement to close the output gap.

(ii) How will the fiscal policy action identified in part (c)(i) affect the following? - The unemployment rate - The natural rate of unemployment

(iii) In closing the output gap, will the automatic adjustment identified in part (b)(i) produce a higher, a lower, or the same price level compared to the fiscal policy identified in part (c)(i) ?

(d) Draw a correctly labeled graph of the market for loanable funds. Show the effect of the fiscal policy action identified in part (c)(i) on the equilibrium real interest rate.

(e) Given the interest rate change identified in part (d), will the long-run aggregate supply curve shift to the right, shift to the left, or remain the same in the long run? Explain.

FRQ 2: The banking system in Country A has limited reserves, and the central bank of Country A has become concerned about a steep decline in investment spending.

(a) Identify an open market operation that Country A's central bank is likely to implement to address the decline in investment spending.

(b) Draw a correctly labeled graph of the money market and show the effect of the central bank's policy identified in part (a) on the nominal interest rate.

(c) Explain the effect of the change in the nominal interest rate shown in part (b) on aggregate demand in the short run.

(d) If the banking system in Country A instead had ample reserves rather than limited reserves, identify a policy action the central bank is likely to implement to address the decline in investment spending.

FRQ 3: Assume that a country's economy is in a short-run equilibrium and the actual unemployment rate is lower than the natural rate of unemployment.

(a) Using a correctly labeled graph of the long-run aggregate supply curve, short-run aggregate supply curve, and aggregate demand curve, show each of the following.

• (i) Current price level, labeled PL1, and current output level, labeled Y1 (ii) The full-employment output level, labeled YF
• (b) Assume the country's banking system has ample reserves. What monetary policy action should the country's central bank use to move the economy toward its long-run equilibrium?

(c) Draw a correctly labeled graph of the country's reserve market, and show how the central bank's action to move the economy toward its long-run equilibrium affects the policy rate in the short run.

(d) Based on the interest rate change from part (c), will each of the following increase, decrease, or remain the same in the short run?

• (i) Real output. Explain. (ii) Natural rate of unemployment

(e) Assume instead that the central bank does not pursue the monetary policy action from part (b) and there was no other government intervention. Will each of the following increase, decrease, or remain the same in the long run?

• (i) Short-run aggregate supply. Explain.
• (ii) Employment

ALL GRAPHS MUST BE DRAWN BY HAND.