Problem 2: Monetary Theory [13 Points] Suppose that an economy begins in long-run equilibrium. Suppose also that there is an increase in Aggregate Demand (AD) as a result of an increase in Net Exports (NX). 3. Does the economy enter an inflationary gap or a recessionary gap? Explain your answer using an AD-AS figure. [2 points] 10. What happen to Money Demand as a result of this shift in the AD-AS model. Does this 11. 12. create a surplus or shortage in the Money Market? Does this create a surplus or a shortage in the bond market? Explain your answer using a MD-MS figure. [3 points] If the Central Bank wants to prevent further inflation, what action could it take? What does it need to do with the Money Supply (MS) to maintain equilibrium in the money market? Explain your answer using both an AD-AS figure and a MD-MS figure. [3 points] If the Central Bank knew that there would be a lag between their decision and their effect on AD, how would this change your answer to Q11 (if at all)? Explain your answer using an AD-AS figure. [2 points] Now suppose that instead of an increase in Aggregate Demand (AD), there is an increase in the Aggregate Supply (AS) Curve. 13. Show what happens to short-run Y and p using an AD-AS figure. Suppose that the Central Bank says that it does not want to intervene to close this output gap because it is worried that doing so might create a deflation. Is this concern justified? Why or why not? Explain your answer using an AD-AS figure. [3 points]