7-4 Homework: Problem Set

Homework: Problem Set

1. A surprise increase in investment spending

A surprise increase in investment spending leads to increase in aggregate demand that in turn leads to increase in the price level and output. Since we are required to keep prices stable at P=100 and our desire is to close an inflationary gap, the government could use contractionary monetary policy or contractionary fiscal policy to decrease the aggregate demand and to balance the price at P=100.

2. Catastrophic floods that cause a sharp food price increase

Catastrophic floods leads to decrease in the level of output and a sharp increase in the ...