Option 1:

Assume that the economy of the United States is operating below full employment.

(a) Draw a correctly labeled graph of long-run aggregate supply (LRAS), short-run aggregate supply (SRAS), and aggregate demand (AD). Label each of the following:

1. current price level, labeled PL₁, and current output level, labeled Y₁
2. full-employment output level, labeled Y_F

(b) On your graph from part (a), illustrate what will happen in the long run if no policy action is taken.

(c) Instead, the government decides to act. Identify and explain a specific fiscal policy action that could move the economy toward full employment output.

(d) Based on your response to part (c), identify and explain the effect on real GDP in the short run.

(e) How will the change in real GDP from part (d) affect the supply of U.S. dollars in the foreign exchange market?

(f) The United States and Canada are trade partners. Draw a correctly labeled graph of the foreign exchange market for U.S. dollars [in Canadian dollars (CAD) per U.S. dollar (USD)], showing the effect of the change in part (e) on the value of the U.S. dollar.