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Table 1 Year Potential GDP Real GDP Price Level 1 $1 020 billion $1 020 billion 100 2 $1 080 billion $1 060 billion 103

Table 1 Year Potential GDP Real GDP Price Level 1 $1 020 billion $1 020 billion 100 2 $1 080 billion $1 060 billion 103 a) Draw a dynamic aggregate demand and aggregate supply diagram to illustrate the state of the economy in Year 1. How can we characterize this position in Year 1? (3 marks) b) Assume in Year 2 that no policy is pursued. Using information contained in Table 1, show in your diagram which you used for part a) where the economy would now be in Year 2. What can you say about the situation this economy is in. (4 marks) c) Illustrate and explain the appropriate fiscal policy to use in this situation in order for the economy to produce at potential GDP in Year 2. (3 marks)

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