Wonderland's economy is characterized by the following:

• Inflation has been mild (below 2%) for years. More recently, it is at 1.5%.
• The natural unemployment rate is estimated to be 5%. For the past 15 months, the unemployment rate has been ranging from 7 to 9%
• GDP growth rate has been in negative territory for the last three quarters.

Questions:

• How would you characterize the economy? Recessionary? Inflationary? Briefly explain why.
• With the help of AD-AS diagram, illustrate the recessionary or inflationary output gap.
• With the help of AE and 45 degree line (also called Income-expenditure equilibrium or Keynesian Cross), illustrate the recessionary or inflationary gap.

As a Keynesian economist, you believe policymakers could change AD to bring the economy to the full employment. Duplicate the diagram in 2) and illustrate the necessary shift in AD curve to achieve the full employment.