Suppose a closed economy (an economy that does not engage in international trade) is described in the following table. Year Potential GDP Real GDP Price Level 1 $1200 billion $1200 billion 100 2 $1200 billion $1400 billion 108

(a) Describe the economic situation in this economy in year 2. What might have caused this problem?

(b) Describe the fiscal policy tools that could be used to combat the problem. Carefully explain all steps in the link between policy and outcomes. What impact will this policy have on the various components of the aggregate expenditures? What will happen to the real GDP and Price level as a result of these policies?

(c) Describe the monetary policy tools that could be used to combat the problem. Carefully explain all steps in the link between policy and outcomes. What impact will this policy have on the various components of the aggregate expenditures? What will happen to the real GDP and price level as a result of these policies?

(d) Will your answers to (b) and (c) change if this was an open economy. In what way?