Aggregate supply and demand with an UPWARD SLOPING SRAS CURVE.

1. Why does the SRAS slope upward to the right. What exogenous force determines the overall position of this upward sloping curve on the graph?

NEXT, you are the boss of an economy that faces a short run situation of less than full employment equilibrium. Your job is to devise a policy that will maximize the chance that full employment equilibrium will be regained. Please do the following using graphs.

2. Show the initial position of your macro- economy using the AD/SRAS graph.

You decide that you want natural long run economic forces to do the readjustment toward full employment (no government intervention).

3. Show how this decision would affect the SRAS, price level and income level on your graph from the short run into the long run.

Now, you are too impatient to wait for the long run adjustments, so you decide to use a government stabilization policy reach full employment.

4. Which policy would you choose and why (closed economy)? (Justify your decision about monetary or fiscal policy in terms our stabilization discussion and points made in the text, Chapter 15).

5. If in (4) you had small open economy and had to choose a policy based on whether your economy had a FIXED or a FLEXIBLE exchange rate, which policy would you choose and why?

6. Let’s say you have a closed economy and decide that the best policy is to use monetary policy to stimulate your economy, but in so doing you create the expectation among producers that there will be a higher inflation and a higher price level in the future. This expectation of higher prices is factored into producers supply decisions.

What happens to your graph? Do these prices expectations make reaching full employment with monetary policy harder or easier? Why?