The AD-AS model in reality For questions 1 through 7, choose one the graphs on the AD-AS model below that corresponds to the following historical events that took place in the U.S. The purpose of this question is to put the AD-AS model to a test against reality. P Y Y 1. In 1965, the U.S. economy stood at roughly full employment with low inflation. Starting in 1965, however, U.S. President Lyndon Baines Johnson began to increase the U.S. involvement in the war in Vietnam, leading to a large increase in defense spending; at the same time, Johnson passed a series of anti-poverty programs known as the \"Great Society,\" including Medicare and Medicaid, which led to a large increase in domestic government spending and transfer payments. Over the next few years, the U.S. economy grew very strongly, and unemployment fell to below 3 percent by 1967. (a) A (b)B (c)C (d) None 2. [...the story continues...] However, inflation began creeping up, from 2.6 percent in 1966 to 5.5 percent by 1969, and unemployment gradually began rising as well, reaching about 5 percent by 1970. (a) A (b)B (c)C (d)D 3. The U.S. economy was at roughly full employment with about 5 percent inflation at the start of 1979. However, a revolution in Iran produced a strongly anti-American government that took Americans as hostages, and during the resulting conflict OPEC engineered a sharp cut in world oil supplies, leading to a sharp increase in oil prices. By the end of 1979 both inflation and unemployment were rising in the US, jeopardizing U.S. President Jimmy Carter's re-election bid in 1980. (a) A (b)B (c)C (d)D 4. [...the story continues...] Carter's initial response to the oil price increase was to fight inflation. He appointed Paul Volcker, an economist well known for his advocacy of tight monetary policy to fight inflation, as the new Chairman of the Federal Reserve. Volcker pursued a tight monetary policy that pushed interest rates very high by early 1980. However, unemployment jumped sharply in early 1980, to over 7 percent. (a) A (b)B (c)C (d)D 5. [...the story continues...] At this point, President Carter changed his mind and decided that fighting high unemployment was more important than fighting inflation. At Carter's request, Volcker adopted a looser monetary policy for the rest of 1980. This prevented further increases in unemployment, but the inflation rate rose to over 10 percent by November 1980; ultimately, President Carter lost his re-election campaign to Ronald Reagan, primarily because voters blamed Carter for stagflation. (a) A (b)B (c)C (d)D 6. [...the story continues...] Upon taking office in 1981, President Reagan decided that fighting inflation was his main priority. At Reagan's request, Paul Volcker and the Fed returned to a tight monetary policy, and nominal and real interest rates soared to record levels during the early 1980s. In 1982-1983, the US economy suffered its worst recession since the 1930s, with unemployment rates peaking at almost 10 percent. However, inflation did start coming down. (a) A (b)B (c)C (d)D 7. [...the story concludes] Between 1980 and 1984, inflation fell from over 10 percent to around 4 percent. Meanwhile, the economy began recovering in 1984, and the unemployment rate by November 1984 was below 7 percent. The good news of lower inflation and improving output and unemployment helped Reagan win re-election in November of 1984. (a) A (b)B (c)C (d)yD