Question

3. Assume that the economy is in long-run equilibrium, with real GDP at the full-employment output level (Y), unemployment rate equal to the natural rate (u), and price level equal to 100. a) Now imagine there is a drop in consumer and business confidence, that is, both groups expect bad economic conditions in the future. Illustrate this change using AS-AD model. What happens to real GDP, unemployment and price level in the short-run? b) What would a Keynesian economist recommend to remedy this situation? What kind of changes would we see in the above graph? c) How would a classical economist respond to this situation? Again, what kind of changes would we see in the graph from part (a)?

          3. Assume that the economy is in long-run equilibrium, with real GDP at the full-employment output level
(Y*), unemployment rate equal to the natural rate (u*), and price level equal to 100.
a) Now imagine there is a drop in consumer and business confidence, that is, both groups expect bad
economic conditions in the future. Illustrate this change using AS-AD model. What happens to real GDP,
unemployment and price level in the short-run?
b) What would a Keynesian economist recommend to remedy this situation? What kind of changes would we
see in the above graph?
c) How would a classical economist respond to this situation? Again, what kind of changes would we see in
the graph from part (a)?

3. Assume that the economy is in long-run equilibrium, with real GDP at the full-employment output level
(Y*), unemployment rate equal to the natural rate (u*), and price level equal to 100.
a) Now imagine there is a drop in consumer and business confidence, that is, both groups expect bad
economic conditions in the future. Illustrate this change using AS-AD model. What happens to real GDP,
unemployment and price level in the short-run?
b) What would a Keynesian economist recommend to remedy this situation? What kind of changes would we
see in the above graph?
c) How would a classical economist respond to this situation? Again, what kind of changes would we see in
the graph from part (a)?

Added by Cheryl B.

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