Suppose the economy is initially in a long-run equilibrium. Starting from this position, assume that an exogenous shock such as the Covid 19 pandemic pushes the economy away from the equilibrium.
Using the IS-LM and AD-AS framework, indicate what happens in the short run to output, unemployment, prices, interest rate, consumption, investments, and real money balances, as the economy moves from long-run equilibrium to short-run equilibrium.
What economic condition is the economy in after the shock? __________________
Short-run
Output ________________
Unemployment _________________
Prices _________________
Interest rate _________________
Consumption _________________
Investment _________________
Real Money Bal _________________
If the government wants to keep output and unemployment constant in the face of the negative demand shock, what should it do (indicate the policy or policies that it should implement).
If the government chooses not to intervene in the economy, what will happen to the above variables in the long run? Please indicate in the space below what will happen in the transition from the short run back to the long run equilibrium and the final values of output and unemployment in the long run.
Output __________________
Unemployment ___________________
Prices __________________
Interest rate __________________
Real Money Bal __________________
Please indicate in the graphs that you provided above (B.1) what curves will shift when the economy moves from the short run back to the long run equilibrium. Please do not submit new (separate) graphs.
What would be the advantage or benefit if the government intervenes in the economy as suggested in B.2 above? On the other hand, what would be a possible benefit if the government does not intervene and instead relies on the economy’s self-correcting mechanism?
Short-run
