Practice Policy Correction 1) A nation is currently producing $500 Billion less output than the full employment level of real output. The economy has a MPC of 0.8 and a reserve requirement of 20%. a. using a correctly labeled AS/AD graph illustrate the following: i. the current price level and real output labeled: PLc and Yc ii. the full employment level of real output labeled: Yfe b. How would each of the following fiscal policy acts need to change in order to correct for economic disequilibrium? i. government spending ii. taxation c. Assume that the government had a balanced budget and paid for the change in spending through borrowing. Draw a correctly labeled graph of the loanable funds market showing the government budgetary action. i. what would happen to the value of the debt? ii. what would happen to the level of future economic growth? d. Based on the original economic situation and your fiscal policy action you suggested in part (b), draw a correctly labeled Phillips curve with the original level labeled C and the correct (post policy action) labeled D. e. Assume that the government did not take the policy action you suggested in part (b) and instead allowed the economy to naturally return to long-term equilibrium. Describe how this natural correction would return the economy to long-run equilibrium. i. on your Phillips Curve illustrate the change created by the natural correction. Label the new long- run equilibrium as point H. F. Now assume that the government has limited reserves and did NOT want to undertake any Fiscal policy but instead wanted the Federal Reserve to correct the original economic disequilibrium. i. describe how the FED could attempt to create a monetary policy solution by conducting open market operations. ii. how much would the initial change in the money supply need to be in order to fix the economic disequilibrium? iii. draw a correctly labeled graph of the money market to illustrate the impact of the open market operation you selected in part (F i). a. how would this monetary policy action impact the following? i. nominal interest rates ii. quantity of investment and interest sensitive consumption iii. aggregate demand iv. price level v. real output iv. Now assume that the government (FED) has ample reserves. a. draw a correctly labeled market for reserves b. illustrate and explain how the FED would need to act in order to effect monetary policy and economic change. c. why did the FED need to make this change and not simply adjust the money supply