PROBLEM SET 2
Econ 302
Spring 2019
Dr. Baker
1.
Assume that 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 and (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.
2.
Policymakers are contemplating undertaking either an increase in government spending
or an increase in the money supply. Either policy is forecast to have the same impact on
3.
Assume that initially everyone expects the price level to stay the same. Now the Federal
Reserve announces that it will increase the rate of money growth in one year. People
in household behavior on output and interest rates. Be sure to label: i. the axes; ii. the
