Suppose that the short-run aggregate-supply has a positive slope. Suppose also that the economy starts at a long-run equilibrium. The principal tool used by the Federal Reserve Bank to change the money supply is open-market operations. Use the aggregate demand-aggregate supply model to illustrate graphically the impact in the short run and the long run of a Federal Reserve decision to reduce open-market purchases, effectively reducing the money supply in our economy. Be sure to label the axes, the curves, the initial equilibrium values, the direction the curve shift and when they do shift, the short-run equilibrium values, and the long-run equilibrium values as the economy adjusts to its long run final equilibrium. State in words what happens to prices and output in the short run and long run.

a. Equilibrium P increases and equilibrium Y decreases.

b. Equilibrium P increases and equilibrium Y remains at the Natural Rate of Output.

c. Equilibrium P and equilibrium Y remain at their initial level.

d. Equilibrium P decreases and equilibrium Y remains at the Natural Rate of Output.

Suppose that the economy starts at a long-run equilibrium and that the short-run aggregate supply curve has a positive slope. Now suppose that a negative demand shock hits the US. No Policy Intervention:Using the model of aggregate demand and aggregate supply developed in Chapter 10, illustrate graphically the impact in the short run and in the long run of this negative demand shock. Be sure to label the axes, the curves, the initial equilibrium values, the direction the curves shift, the short-run equilibrium values, and the long-run equilibrium values. Explain what happens to prices and output in the long run.

a. Equilibrium P increases and equilibrium Y decreases.

b. Equilibrium P decreases and equilibrium Y remains at the Natural Rate of Output.

c. Equilibrium P and equilibrium Y remain at their initial level.

d. Equilibrium P increases and equilibrium Y remains at the Natural Rate of Output.

Policy Intervention: Suppose that you are an economist working for the Treasury Department (thus, you can only use fiscal policy tools) when this negative demand shock is observed. Using the model of aggregate demand and aggregate supply developed in Chapter 10, illustrate graphically your policy recommendation to accommodate this adverse demand shock, assuming that your top priority is maintaining full employment in the economy. Be sure to label the axes, the curves, the initial equilibrium values, the direction the curves shift, the short-run equilibrium values, and the long-run equilibrium values. Explain what happens to prices and output in the short-run and the long run.

a. Equilibrium P increases and equilibrium Y decreases.

b. Equilibrium P decreases and equilibrium Y remains at the Natural Rate of Output.

c. Equilibrium P and equilibrium Y remain at their initial level.

d. Equilibrium P increases and equilibrium Y remains at the Natural Rate of Output.