Assume the Economy Is Initially in a Short-Run Equilibrium at a Level

question 44

Essay

Assume the economy is initially in a short-run equilibrium at a level of output below the natural rate. a.Use the IS-LM model to graphically illustrate:
1. how the economy will adjust in the long-run if the no-policy action is taken.
2. the long-run equilibrium if fiscal policy is used to return the economy to the natural rate of output.
b.Explain how investment, the interest rate, and the price level differ in the new long-run equilibrium in the two cases.

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Definitions:

Quoted Price

The current price at which an asset or service can be bought or sold, often provided in financial markets or by vendors.

Natural Hedge

A transaction between two counterparties where both parties’ risks are reduced.

Derivatives Transaction

A financial agreement whose value is based on, or derived from, the value of an underlying asset or group of assets.

Arbitrage Profits

Profits generated from exploiting price differences of the same asset in different markets, buying low in one and selling high in another.