Problem Questions

Students are required to answer all the questions and sub-questions of the assignment. Please show all your work – graphs, formulas, and calculations (wherever necessary) to receive full credit. Just showing the final answer to a question will lead to a grade of zero.  

1. (50 points) Draw a graph of the overall economy using the Neoclassical economic model, including the LRAS, SRAS, and AD curve. Draw the model so that this economy is operating at its full potential.
   1. Based on this information, is the economy operating with an unemployment rate that is above or below the natural unemployment rate?
   2. If AD were to suddenly increase, what would happen to the price level and Real GDP in this economy immediately after the increase? Show on you graph.
   3. If AD were to suddenly increase, what would eventually need to happen to the SRAS curve for the economy to, once again, operate at its full potential? Show on you graph.
2. (50 points) For the following questions, evaluation whether the statement is “true” or “false”. Then, provide a brief explanation to justify your answer.
   1. In the Keynesian model (such as the one shown in Figure 12.3), an increase in AD will always lead to more Real GDP.
   2. The general lesson from the Phillips curve is that an increase in inflation rates will lead to lower unemployment rates in the short-run.
   3. If the economy is struggling, Keynes recommends that the government raise taxes in order to stimulate the economy.
   4. The economy will adjust more quickly if people generally exhibit adaptive expectations (rather than rational expectations).
   5. Suppose that researchers find that prices in the U.S. are very slow to adjust (“sticky prices”). This finding will tend to favor an economy that is in line with Keynesian economic thinking.