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Question 1 (4 marks) Consider an economy that is initially in long-run equilibrium as drawn in the following graph where LRAS is the long-run AS
Question 1 (4 marks) Consider an economy that is initially in long-run equilibrium as drawn in the following graph where LRAS is the long-run AS curve, AD1 is the aggregate demand curve, SRAS1 is the short-run AS curve, Y(fe) is the potential output under full employment, and P1 is the equilibrium aggregate price level. a. Use the AD/AS model for this question. Illustrate using graphs when the economy's central bank buy more government bonds. Identify on the graph the new short run aggregate price level and the new short run level of real GDP. (1) b. Illustrate verbally what happened corresponding to the graph you just drawn above. Explain the effects of the shift of AD curve on the aggregate price level.. What happened to the aggregate price level relative to its initial level? (1) c. Illustrate using a graph how the economy you depicted in (a) will adjust in the long run. On the graph identify the long run price level and the long run level of aggregate output. Explain verbally your results. In your answer make sure you comment on what is happening to wages and prices during this long run adjustment. (2)
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