a. Using the AD-AS model, show what a contractionary gap looks like graphically. Make sure to label the axis, curves, equilibrium, and contractionary gap. Explain in a sentence or two why this is a problem. (10 points)
b. On a new graph, show the effect on the economy from part a if the Federal Reserve decides to lower the discount rate, but that this is only enough to half close the contractionary gap. Explain in a sentence or two what has happened to the short-run equilibrium of this economy. (10 points)
c. On a new graph, show the effect on the economy from part b if the government lowers taxes enough to fully close the contractionary gap. Explain in a sentence or two what has happened to the short-run equilibrium of this economy. (10 points)
d. Which school of thought on business cycles was used in this scenario? How do you know? What is a benefit of this school? What is a problem associated with this school? Pick one other school of thought and explain why they would argue against this school. (10 points)
2) Imagine that the economy of the United States is in an expansionary gap.
a. Using the AD-AS model, show what an expansionary gap looks like graphically. Make sure to label the axis, curves, equilibrium, and expansionary gap. Explain in a sentence or two why this is a problem. (10 points)
b. On a new graph, show the effect on the economy from part a if the Federal Reserve decides to sell securities through open market operations, but that this is only enough to half close the expansionary gap. Explain in a sentence or two what has happened to the short-run equilibrium of this economy. (10 points)
c. On a new graph, show the effect on the economy from part b if the Federal Reserve raises the reserve requirement, and that this fully closes the expansionary gap. Explain in a sentence or two what has happened to the short-run equilibrium of this economy. (10 points)
d. Which school of thought on business cycles was used in this scenario? How do you know? What is a benefit of this school? What is a problem associated with this school? Pick one other school of thought and explain why they would argue against this school. (10 points)
3) Imagine that the economy of the U.S. is in long-run equilibrium.
a. On a new graph, show the effect on the economy from part a if a trade war with the U.S. begin where the U.S. puts tariffs on China first, and then China retaliates after with their own tariffs. Explain in a sentence or two what has happened to the short-run equilibrium of this economy. (10 points)
b. What are five benefits of free trade policies? (5 points)
