Question 3: Contemporary Economic Applications Suppose a hypothetical scenario in which recent research suggests that a reduction in the growth rate of the United States economy will cause a downturn in the global economy. The UK government has commissioned a select committee to analyse the economic impacts on the UK economy of such a scenario. You are working for the HM Treasury and the select committee have asked you to provide further guidance on the above situation. Using economic theory, answer the following (Show your workings, round to 3 d.p. when necessary):

a. Discuss how a decline in global economic activity could cause actual growth to deviate away from its potential output in the UK. Why could it be suggested that there maybe longer run impacts to the UK's productive capacity? (5 Marks)

b. To what extent could deviations in real output and the interest rate cause changes in the equilibrium and disequilibrium level of unemployment? (5 Marks)

c. "Any volatility in output and unemployment from the external shock would be due to slow market adjustment. Policy-making should be focussed towards re-correcting any longer run rigidities over short run demand management". Discuss and critique the statement. (10 Marks)

d. Evidence has suggested that the marginal propensity to consume, the elasticity of changes in interest rates on investments, and the relative strength of interest rate changes on speculative motives for liquidity are reducing in the UK due to consumer reactions. Discuss the relative impact of these effects on fiscal and monetary policy, and as such, the readiness of the UK Government to counteract both demand-side and supply-side shocks from the global economic slowdown. (5 marks)

e. Why could it be suggested that any monetary policy responses would have no real effect in the long run? (5 Marks)