QUESTION B3

The figure below depicts aggregate demand and aggregate supplyin the nation of Pacifica in 2018.

At the beginning of 2019, a wave of business optimism ledproducers to sharply increase their planned investmentexpenditure.

1. What effect, if any, will this increased investment expenditurehave in the short-run on the Aggregate Demand curve? The Short-RunAggregate Supply curve? [TYPE YOUR ANSWERBELOW]

1. After the increased investment expenditure, will short-runequilibrium real GDP be above or below potential GDP? How do youknow? [TYPE YOUR ANSWER BELOW]

1. After the increased investment expenditure, if the governmenttakes no action how will Pacifica’s economy adjust over time tomove towards its long-run equilibrium? (Note: for full credit youmust explain not only what happens to move the economy tolong-run equilibrium, but also why it happens.)[TYPE YOUR ANSWER BELOW]

The president of Pacifica is concerned about the effect of thisnew investment expenditure on the economy, and she wishes to usemonetary policy to move equilibrium GDP back toward potential GDP.(For the remainder of the question, assume that the PacificaCentral Bank is Pacifica’s version of the United States FederalReserve and that Pacifica’s banking and financial systems workexactly like the United States’ banking and financial systems.)

1. Which one of the following policies would help the presidentachieve her aim? [TYPE YOUR ANSWER BELOW]

1. Direct the Pacifica Central Bank to sell Pacifica TreasuryBills
2. Direct the Pacifica Central Bank to purchase Pacifica TreasuryBills

The figure below represents the money market in Pacifica justafter the increase in investment expenditure but before thegovernment undertakes the monetary policy you chose in part(d).

1. Explain why the Money Demand curve has a negative slope. (Note:you must say more than that money demand increases as the interestrate decreases, and vice versa. You must explain why thisis the case.) [TYPE YOUR ANSWER BELOW]

1. What effect (if any) will the monetary policy you chose in part(d) have (in the short-run) on the Money Supply curve? The MoneyDemand curve? The equilibrium interest rate? [TYPE YOURANSWER BELOW]

1. What impact (if any) will this monetary policy have (in theshort-run) on Aggregate Expenditure? (If it does have an effect onAggregate Expenditure, explain which component or components ofAggregate Expenditure will be most affected.) [TYPE YOURANSWER BELOW]

1. What impact (if any) will this monetary policy have onshort-run equilibrium real GDP and the short-run equilibriumAggregate Price Level? [TYPE YOUR ANSWERBELOW]