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##### Suppose output is below potential output in year 0. Prices that year are given by P.

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Suppose output is below potential output in year 0. Prices that year are given by P. In year 1;(with the level of potential output unchanged), the Fed stimulates the economy by shifting the;aggregate demand curve until it intersects the point (P0,Y*).;(a) Sketch the aggregate demand curve for years 0 and 1. Describe the actions taken by the;Fed.;(b) Assume that the price adjustment process is given by Equation 9.2 [(1 + (Y 1 -Y*/Y*)].;If inflation in year 0 was zero, how do prices behave in year 1? Sketch the price;adjustment curve for year 1.;(c) Explain why output in year 1 is above potential.;(d) In which direction should the Fed have shifted the aggregate demand curve to set Y1 =;Y*? Is it possible to say?;(e) Given the Feds action, is it possible to say whether prices will increase or decrease in;year 2? Why or why not?

Paper#29415 | Written in 18-Jul-2015

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