Problem
It is the year 2025. COVID-19 has been cured and the Canadian economy has returned to a long- run equilibrium with output equal to potential output at Y". Suppose it is suddenly determined that a new virus has been found to have begun to infect people in the Amazon Rainforest. This shakes the confidence of Canadian consumers and they begin to reduce their spending. Assume that this is the only impact on the economy at this point.
1. Using an AD-AS diagram, illustrate the initial position of the economy and the impact of this shock.
2. If no intervention was taken, explain what would likely happen to the economy to return it to a long-run equilibrium. Illustrate this on your diagram.
3. Would the process described in part (1) likely be a fast or slow process? Explain.
4. Name three possible policies that the government could take to restore the economy to Y* more quickly.
5. Explain why it might be difficult for the government to implement these policies successfully. What risks does the government run with using them?