The economy of a hypothetical country has been stable for two or three years with very low unemployment. Wages have been gradually increasing during this time. Now stock market prices begin significant increases, causing peoples' investments, such as their retirement accounts and other investments to increase in value. People feel very good about the future, that they will keep their jobs, get regular pay raises and life will be good. With this positive feeling, people feel better about making purchases that perhaps they had been delaying earlier. They now use their new-found sense of wealth to buy many things that they had been hesitant to purchase in the past.

Given this scenario, insert your answers below each of the following questions.

a. What kind of economic gap will start to occur (inflationary or recessionary)?

b. Which of these graphs, Figure 1 or Figure 2, depicts this economic gap?

Figure 1 D2 LRAS 51 P1 DI Deal GDP Figure 1: Graph of the economy showing demand shifted to the right. Figure 2 LRAS D1 51 D2 P1 D1 Real GDP Figure 2: Graph of the economy showing demand shifted to the left