Question 1: Aggregate Demand and Aggregate Supply

Assume the U.S. economy is in long-run equilibrium. Analyze each of the following events independently and include answers to the following in your analysis: (1) Explain whether AD or SAS changes and why the change occurred. (2) Explain what happens to the equilibrium price level and equilibrium output in the U.S. in the short run. (3) Describe the type of gap facing the economy. (4) Draw a graph to illustrate your answer.

a. The bubble in the housing market bursts, and prices of houses quickly begin to fall.

b. With plenty of slack in the labor market, firms lower wages.

c. Anticipating the possibility of war, the government increases its purchases of military equipment.

d. Productivity in the U.S. continues to increase.

Question 2: More Aggregate Demand/Aggregate Supply

a. Suppose the United States' economy is in short run equilibrium producing RGDP equal to $150 billion. Potential GDP equals $250 billion. The marginal propensity to consume in the U.S. is 0.5. Draw a graph illustrating the U.S. economy. Is the economy characterized by a recessionary gap or an inflationary gap? What problems does the gap present for United States?

b. You are an economic advisor to the President. He asks you to design a fiscal policy to close the gap. What fiscal policy do you propose? Why did you choose this particular policy? Explain how your policy works. Draw a graph illustrating your answer.

c. Describe any costs the United States may bear in the long run due to the implementation of the policy you designed in part (b).

d. If your policy is not acceptable to Congress, describe the self-correction mechanism by which the economy could return to long-run equilibrium. Draw a graph illustrating the self-correction process. Describe any costs the United States may pay with self-correction.

Question 3: The Federal Reserve System (the Fed).

a. Describe the structure of the Federal Reserve System.

b. The government of Turtleville uses measures of monetary aggregates similar to the United States, and the central bank of Turtleville imposes a required reserve ratio of 10%. Given the following information, answer the questions below.

Bank deposits at the central bank = $200 million
Currency held by the public = $150 million
Checkable bank deposits = $500 million
Currency in bank vaults = $100 million
Traveler's checks = $10 million

1. M1 = _____________

2. The Monetary Base = _____________

3. Excess Reserves = _______________

4. The amount by which commercial banks in Turtleville can increase checkable deposits: _____________